reconciling clv formulas
Reconciling and Clarifying CLV Formulas
Peter S. Fader www.petefader.com Bruce G. S. Hardie www.brucehardie.com †
March 2012
1
Introduction
A standard part of many contemporary Marketing courses is a case or exercise in which students are expected to compute customer lifetime value (CLV).
Typically they are given an average retention rate r, an average net cashflow of $m per period (having accounted for “account maintenance” costs), and an assumed discount rate d. Given these inputs, they are asked to determine the lifetime value of a customer; see, for example, Mart´ınez-Jerez and Dillon
(2007) and McGovern (2007).
Although these inputs are fairly similar across these exercises, the formula that the students are expected to use in order to complete this task will depend on which CLV reading has been provided to them.
• If given Blattberg et al. (2008) or Steenburgh and Avery (2011), they will use m(1 + d)
CLV =
.
(1)
1+d−r
• If given Capon (2007), Kotler and Keller (2012), or Lehmann and Winer
(2008), they will use mr CLV =
.
(2)
1+d−r
• If given Ofek (2002) or Davis (2007), they will use
CLV =
†
m
.
1+d−r
c 2012 Peter S. Fader and Bruce G. S. Hardie.
<http://brucehardie.com/notes/024/>.
1
(3)
This document can be found at
(In accounting for the differences in notation across the above references, customer acquisition costs have been excluded from these formulas.)
What is rather disconcerting is that a large number of our colleagues around the world who are teaching customer lifetime value in Marketing courses are unaware of the existence of these “competing” formulas and therefore do not call attention to the interesting and important factors that underlie these differences. In this note, we cast light upon these differences and, in so doing, motivate the need for students to better understand what they are learning (and, in some cases, for professors to better understand what they are teaching).
2
Understanding the Different Formulas
The answer to
Peter S. Fader www.petefader.com Bruce G. S. Hardie www.brucehardie.com †
March 2012
1
Introduction
A standard part of many contemporary Marketing courses is a case or exercise in which students are expected to compute customer lifetime value (CLV).
Typically they are given an average retention rate r, an average net cashflow of $m per period (having accounted for “account maintenance” costs), and an assumed discount rate d. Given these inputs, they are asked to determine the lifetime value of a customer; see, for example, Mart´ınez-Jerez and Dillon
(2007) and McGovern (2007).
Although these inputs are fairly similar across these exercises, the formula that the students are expected to use in order to complete this task will depend on which CLV reading has been provided to them.
• If given Blattberg et al. (2008) or Steenburgh and Avery (2011), they will use m(1 + d)
CLV =
.
(1)
1+d−r
• If given Capon (2007), Kotler and Keller (2012), or Lehmann and Winer
(2008), they will use mr CLV =
.
(2)
1+d−r
• If given Ofek (2002) or Davis (2007), they will use
CLV =
†
m
.
1+d−r
c 2012 Peter S. Fader and Bruce G. S. Hardie.
<http://brucehardie.com/notes/024/>.
1
(3)
This document can be found at
(In accounting for the differences in notation across the above references, customer acquisition costs have been excluded from these formulas.)
What is rather disconcerting is that a large number of our colleagues around the world who are teaching customer lifetime value in Marketing courses are unaware of the existence of these “competing” formulas and therefore do not call attention to the interesting and important factors that underlie these differences. In this note, we cast light upon these differences and, in so doing, motivate the need for students to better understand what they are learning (and, in some cases, for professors to better understand what they are teaching).
2
Understanding the Different Formulas
The answer to
References: Berger, Paul D. and Nada I. Nasr (1998), “Customer Lifetime Value: Marketing Models and Applications,” Journal of Interactive Marketing, 12 (Winter), 17–30. Blattberg, Robert C., Byung-Do Kim, and Scott A. Neslin (2008), Database Marketing: Analyzing and Managing Customers, New York: Springer. Capon, Noel (2007), Managing Marketing in the 21st Century, Bronxvile, NY: Wessex. Davis, John (2007), Measuring Marketing: 103 Key Metrics Every Marketer Needs, Singapore: John Wiley & Sons (Asia). Dev, Chekitan S. and Laure Mougeot Stroock (2007), “Rosewood Hotels & Resorts: Branding to Increase Customer Profitability and Lifetime Value,” Harvard Business Publishing HBP No. 2088 (June 15, 2007). Fader, Peter S. and Bruce G. S. Hardie (2007), “How to Project Customer Retention,” Journal of Interactive Marketing, 21 (Winter), 76–90. Fader, Peter S. and Bruce G. S. Hardie (2009), “Probability Models for CustomerBase Analysis,” Journal of Interactive Marketing, 23 (January), 61–69. Fader, Peter S. and Bruce G. S. Hardie (2010), “Customer-Base Valuation in a Contractual Setting: The Perils of Ignoring Heterogeneity,” Marketing Gupta, Sunil and Donald R. Lehmann (2005), Managing Customers as Investments, Upper Saddle River, NJ: Wharton School Publishing. Gupta, Sunil, Donald R. Lehmann, and Jennifer Ames Stuart (2004), “Valuing Customers,” Journal of Marketing Research, 41 (February) 7–18. Kotler, Philip and Kevin Lane Keller (2012), Marketing Management (14th edn), Upper Saddle River, NJ: Prentice Hall. Lehmann, Donald R. and Russell S. Winer (2008), Analysis for Marketing Planning (7th edn), New York, NY: McGraw-Hill/Irwin. Mart´ınez-Jerez, F. As´ıs and James R. Dillon (2007), “Kansai Digital Phone: Zutto, Gaining Japanese Loyalty,” Harvard Business School Case 9-106-006 (rev. March 27, 2007). McGovern, Gail (2007), “Virgin Mobile USA: Pricing for the Very First Time,” Harvard Business School Case 9-504-028 (rev Ofek, Elie (2002), “Customer Profitability and Lifetime Value,” Harvard Business School Note 9-503-019 (rev. August 7, 2002). Steenburgh, Thomas and Jill Avery (2011), “Marketing Analysis Toolkit: Customer Lifetime Value Analysis,” Harvard Business School Note 9-511-029 (rev