Customer Value: RFM and CLV

Transcription

1 Study Unit 1 Customer Value: RFM and CLV ANL 309 Business Analytics Applications

2 Introduction Concept of customer value Recency-Frequency-Monetary y y Value (RFM) approach to calculate customer value Customer Lifetime Value (CLV) approach to calculate customer value Calculating CLV Differentiation between the RFM and CLV approaches

3 Customer Value Customer Value (or customer profitability): Making a company s relationship with its customers profitable The understanding di of customer value that t enables a company to organise different parts of its infrastructure to support different segments of customers, in a cost-effective way. Customer value is difficult to define and calculate

4 Approaches to Estimate Customer Value There are currently a number of approaches to estimate customer value. Recency-Frequency-Monetary Value (RFM) Approach Customer Value Lifetime (CLV) Approach

5 Recency-Frequency-Monetary Value (RFM) The RFM approach utilises three aspects to estimate customer value: Recency (R) measures how long since a customer last placed an order with company. Frequency (F) measures how often a customer orders from the company within a specified period. Monetary value (M) measures the amount a customer spends on the average.

6 BA Models for Former Customers Sort customer data for customer database using RFM criteria, group them into equal quintiles, and analyse the resulting data Calculate relative weights for RFM using regression techniques, use those weights to calculate the total effects of RFM.

7 RFM: An Example A business wants to send a marketing mailer campaign to its customers. It has a customer base of 400,000 and it has selected a sample of 10%=40,000 for the purpose of test marketing.

8 Recency Coding A company sends campaign mailers to 40,000 customers in the test group. Assume that 20% of 40,000=808 customers responded. It then sorts the test group of 40, in decreasing order of most recent purchase date. It divides the result into five equal groups or quintiles (20% in each group). And finally assigns a recency code to each quintile: the top most group has a recency code of 1 and so on, up to 5.

9 Recency Coding

10 Frequency and Monetary Value Coding Both are similar in procedure to recency coding. In the case of frequency coding, the data are sorted based on frequency, such as the average number of purchases made by a customer per month. In the case of monetary value, sorting is based on the monetary value, such as the average money value of purchase made per month.

11 Frequency Coding

12 Monetary Value Coding

13 Limitations of RFM RFM may not produce an equal number of customers under each RFM cell because the individual metrics R, F and M may be correlated. For instance, a customer with a high M is also likely to have a high F. Backward looking as it applies to the historical customer data available. Hence, its use is limited to established customers.

14 Same Number of Individuals in Each RFM

15 Customer Lifetime Value (CLV) The Customer Lifetime Value (CLV): To estimate the customer value of prospective or established customers The Customer Lifetime Value (CLV): The expected present value of a prospect or customer over a specified period of time

16 Components of CLV Estimation Generally, estimation of CLV involves the following components: Duration Time Interval Profits=Total Revenue-total Cost Discount Rate

17 Calculating CLV The simplest and most common definition of CLV: The sum of the discounted profits over the duration of the customer lifetime (T) with the firm

18 Discount Rate The discount rate depends on the market interest rate r and it is given by

19 Computing the CLV Year Future Profit ($)

20 a) Calculate the Discount Rate The interest rate r is 5% or Discount rate for the first year =1/(1+0.05) =0.952 Discount rate for the second year And so on

21 b) Calculate the Net Present Value for Each Year The net present value at period t is the expected profit multiplied by the discount rate. Net present value for year 1 =$1,000*0.952 =$952 Net present value for year 2 =$2,000*0.907 =$1,814 And so on

22 c) Calculate the Customer Lifetime Value of this Customer CLV is the sum of the discounted profits or net present values over the duration of the customer lifetime T with the firm. For this customer, T=5 years. Hence, CLV= =12570

23 Computing the CLV