Customer lifetime value calculations KEM Company has begun studying customer lifetime value for its customers and has prepared the information below for selected customers. For simplicity, management has assumed that for a given customer, the retention rate is the same every year until the customer departs. For Customer 4, costs (ct) were incurred to promote customer retention in years 1 and 2.
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CUSTOMERS |
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1 |
2 |
3 |
4 |
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Initial acquisition cost |
$1,000 |
$1,000 |
$1,000 |
$1,000 |
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n = number of years retained |
5 |
3 |
5 |
5 |
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r = retention rate for each of the n years retained |
1 |
1 |
0.9 |
1 |
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Cost of capital |
0.1 |
0.1 |
0.1 |
0.1 |
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Mt = margin from customer in year t |
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M1 |
$275 |
$300 |
$275 |
$275 |
|
M2 |
275 |
300 |
275 |
275 |
|
M3 |
275 |
300 |
275 |
300 |
|
M4 |
275 |
— |
275 |
300 |
|
M5 |
275 |
— |
275 |
300 |
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ct = additional costs to serve and retain customer in year t |
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c1 |
$0 |
$0 |
$0 |
$50 |
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c2 |
0 |
0 |
0 |
25 |
|
c3 |
0 |
0 |
0 |
0 |
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c4 |
0 |
— |
0 |
0 |
|
c5 |
0 |
— |
0 |
0 |
Required
(a) Compute the customer lifetime value for each customer for the stated number of years.
(b) Discuss the reasons for differences in customer lifetime value between Customers 1 and 2, Customers 1 and 3, Customers 1 and 4, and Customers 3 and 4.
(c) Compute the customer lifetime value for Customers 1, 2, and 3 assuming that n is very large and the numbers in the table remain about the same each year.
(d) How does information on a customer’s estimated lifetime value help a company manage its customer acquisition and loyalty programs?