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Marketing management by prof natalie mizik lecture 04

Two Sides of Customer Value:

Economic Value to the Customer

(EVC)

and

Life Time Value of a Customer (LTV)

Session 4

Marketing Management

Prof. Natalie Mizik



Marketing Management:

The Big Picture


I. Situation
Analysis
(5Cs)

COLLABORATORS

II. Set Strategy SEGMENTATION
(STP)

III. Formulate
Marketing
Programs
(4Ps)

PRODUCT

CUSTOMERS

TARGETING

PRICE

COMPANY

COMPETITION

CONTEXT

POSITIONING

ACQUISITIONRETENTION

PROMOTION

PLACE

Prof. Natalie Mizik – 2010 MIT 15.810



Sources of Customer Value

Psychological

Economic

Functional

Prof. Natalie Mizik – 2010 MIT 15.810


1. Economic Value to
Customers


EVC is the total (life-cycle) cost savings from using a
new product in place of a current product.

 EVC

= (Total ownership cost of existing product)

– (Total ownership cost of new product)

 Maximum

Willingness to Pay = Total
lifecycle savings from new product compared

with old product
Prof. Natalie Mizik – 2010 MIT 15.810


Example: New Telecom

Switch


Total cost of purchase

$1,000
$300 Price

Economic value
of $125
Maximum value
(at a zero price)

$375 Price

$100 Installation

$100 Installation

$400 Usage and
maintenance

$400 Usage and
maintenance

Value drivers of
new solution

Economic value
and price position

$200 Installation
$500
$500 Usage and
maintenance
$0

Benchmark
comparison

Image by MIT OpenCourseWare.

Prof. Natalie Mizik – 2010 MIT 15.810


Sources of EVC


Total cost of purchase

Price paid
Acquisition costs
Usage costs
Maintenance costs
Ownership costs
Disposal costs

Amazon.com lower purchase price with the on-line purchase of
books.
American Hospital Supply reduces a hospital's cost with a
computerized customer order program.
Sealed Air reduces labor cost in packaging with AirCap.
Saturn lowers the cost of repair and insurance through module
product design.
GE Capital works with customers to create affordable
ownership.
Rohm-Haas's Kathon MWX cuts cost of disposal of
machine fluid waste in half.
Image by MIT OpenCourseWare.

Prof. Natalie Mizik – 2010 MIT 15.810


Example



Lasik
The Canon and Lexmark printers are the
cheapest, or are they?

© source unknown. All rights reserved. This content is excluded from our Creative
Commons license. For more information, see http://ocw.mit.edu/fairuse.

Prof. Natalie Mizik – 2010 MIT 15.810


Example



A new synthetic motor oil is about to be
introduced with the primary benefit that it needs
to be changed less frequently, specifically once
every year regardless of the mileage. Assuming
current oils need to be changed every 3,000
miles at a cost of $30 per change (oil at a dollar
a quart or a total of $5 per car, labor $20,
disposal of oil $5) for an average car. What is
the EVC of the new oil to a car driver who drives
15,000 miles per year?

Prof. Natalie Mizik – 2010 MIT 15.810


EVC by Customer

Old Product
New
Product

Low Mileage
(3,000)

Average
Mileage
(15,000)

High Mileage
(45,000)

Product Price

???

1x5=5

25

15x 5 = 75

Labor Costs

20

1 x 20 = 20

100

15 x 20 = 300

Other Costs
(disposal fee)

5

1x 5 = 5

25

15 x 5 = 75

TOTAL COST

25 + price

30

150

450

EVC

5

125

425

EVC/Quart

1

25

85

Prof. Natalie Mizik – 2010 MIT 15.810


Issues in Using EVC


Customer differences


High vs. low mileage drivers.



Convincing customers



Other (fuzzy) benefits ignored



BUT, EVC can be useful in




Pricing
Segmentation
New product introduction

Prof. Natalie Mizik – 2010 MIT 15.810


What is Customer Lifetime

Value (CLV aka LTV)?

• Customer Lifetime Value
is the net present value of all
future streams of profits that a
customer generates over the life
of his/her business with the firm

Prof. Natalie Mizik – 2010 MIT 15.810


Creating or Destroying

Value?

“In the United States, top executives
lose their jobs when their companies
sell too little. In Britain, it can happen
when their companies sell too much.”
—The New York Times, March 31, 1993


Prof. Natalie Mizik – 2010 MIT 15.810


Appropriating Value


The Two Sides of Customer

Value

High

Value
of
Customers

Vulnerable
Customers

Lost
Cause

Low

Star
Customers

X
Free Riders

Low

High

Value to Customers

Creating Value

Prof. Natalie Mizik – 2010 MIT 15.810


Value of Tennis Club

Member

You own a tennis club where the annual membership
fee is $300. The average club member spends about
$100 dollars a year at the club (in balls, drinks, snacks,
etc.). The annual cost of these miscellaneous goods
(the balls, drinks, snacks, etc.) to you is $40 per
player. On average people who join a tennis club have
a playing career of 7 years. Historically, 65% of the
members in a given year rejoin the following year.
Investing capital at the going rate would earn a return
of 8% a year. Based on this information, what is the
long-term value of a customer?
Prof. Natalie Mizik – 2010 MIT 15.810


LTV Calculations

Expected
profit

Discount
factor

Expected
discounted
profit

Annual profit

Retention
Probability

Assumptions

Constant

r = .65

Year (A)

(B)

(C)

(D) = (B) x (C)

(E)

(F) = (D) x (E)

0

360

1.00

360.00

1.00

360.00

1

360

0.65

234.00

0.93

216.67

2

360

0.42

152.10

0.86

130.40

3

360

0.27

98.87

0.79

78.48

4

360

0.18

64.26

0.74

47.23

5

360

0.12

41.77

0.68

28.43

6

360

0.08

27.15

0.63

17.11

d = .08

LTV =

Prof. Natalie Mizik – 2010 MIT 15.810

878.32



Profit and Defection Patterns
Credit Card Industry

Profit Pattern
Defection Pattern

150

50


667075
42


9699105

92
86

0

0 1 2 3 4 5 6 7 8 9
-50 -40

100
100
Accounts Remain

Annual Prof

100


120

82
80

76

70

66

60


60


56

47
40

40


34

20
0

Customer Tenure

0

1

2

3

4

5

6

7

8

9

Customer Tenure

($42) *(.82) ($66) *(.76)
(m)(r) (m)(r 2 )
CLV 

 ... 


 ....  AC

2
2
(1 0.1)
(1 0.1)
(1 i) (1 i)
17
Prof. Natalie Mizik – 2010 MIT 15.810


Measuring Customer Value


Lifetime value of a customer assuming
infinite horizon:
 r 
LV  m
  AC
 1 i  r 

m = margin
i = discount rate
r = retention rate
AC = acquisition cost
18
Prof. Natalie Mizik – 2010 MIT 15.810


Economics of Customer

Acquisition for FedEx









140 accounts in advertising industry use
2,285 Courier Paks (CP) per month
CP price is $12.50 and variable cost is
$4.25
Retention rate = 0.9, discount rate = 12%

What is the maximum FedEx should be
willing to spend to acquire a new account
in this industry?
Prof. Natalie Mizik – 2010 MIT 15.810


Margin Multiple

Constant Margins

r

1 i  r


Retention
Rate
60%
70%
80%
90%

10%
1.20
1.75
2.67
4.50

Discount Rate
12%
14%
1.15
1.11
1.67
1.59
2.50
2.35
4.09
3.75

Prof. Natalie Mizik – 2010 MIT 15.810

16%
1.07
1.52
2.22
3.46


Margin Multiple

Growth in Margins

r

1 i  r(1 g)

Retention
Rate
60%
70%
80%
90%

0%
1.15
1.67
2.50
4.09

2%
1.18
1.72
2.63
4.46

Growth Rate
4%
6%
1.21
1.24
1.79
1.85
2.78
2.94
4.89
5.42

Prof. Natalie Mizik – 2010 MIT 15.810

8%
1.27
1.92
3.13
6.08


Increasing Customer

Equity:

Three strategies:
I.

Customer acquisition (gain new customers)


II.

Customer expansion


III.

Customer retention


 r 
LV  m
  AC
1 i  r 

Prof. Natalie Mizik – 2010 MIT 15.810


Drivers of CLV

FIRM VALUE


Financial
Value

PROFITS &
CASH FLOW

Customer
Equity

CUSTOMER
PROFITABILITY

Drivers of
Customer
Value

CUSTOMER
ACQUISITION

CUSTOMER
RETENTION

Prof. Natalie Mizik – 2010 MIT 15.810

CUSTOMER
EXPANSION


I. Customer Acquisition

Strategies



Marketing



Affiliations



Merges and Acquisitions

E*Trade

amazon.com

AT&T

Prof. Natalie Mizik – 2010 MIT 15.810


Customer Acquisition Costs

by Marketing Activity


Source: Customer acquisition cost--a key marketing metric. Justin Zohn. NPN, National
Petroleum News, April 2003.
Prof. Natalie Mizik – 2010 MIT 15.810


Mergers & Acquisitions in the

Wireless Industry (1999-2000)

Mergers & Acquisitions in the Wireless Industry (1999-2000)

$21,639

$20,000
$15,000
$10,000
$5,000

$6,741

$7,462

$8,306

$8,550

$4,110

$-

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da
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ia
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ue
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Cost Per Subscriber ($)

$25,000

Source: Based on data from The Industry Standard, Aug 7, 2000 and Business Week, August 7, 2000


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