HBS Toolkit

LICENSE AGREEMENT

HBS Toolkit License Agreement Harvard Business School Publishing (the Publisher) grants you, the individual user, limited license to use this product. By accepting and using this product, you agree to the terms of service described below. Terms You accept that this product is intended for your use, and you will not duplicate in any form or manner, electronic or otherwise, copies of this product nor distribute this product to anyone else. You recognize that the product and its content are the sole property of the Publisher, and that we have copyrighted the product. You agree that the Publisher is not responsible for any interruption of service or malfunction that is a consequence of the Internet, a service provider, personal computer, browser or other software or hardware components. You accept that there is no guarantee that this product is totally error free. You further understand and accept that the Publisher intends to provide reliable information but does not guarantee the accuracy or completeness of any information, and is not responsible for any results obtained from the use of such information. This license is effective until terminated, when the license or subscription period ends without renewal, or when you destroy this product and any related documentation. The Publisher may terminate your license without notice if you fail to comply with the conditions set forth in this agreement, and may pursue any other legal recourse.

Copyright 1999 President and Fellows of Harvard College

Lifetime Customer Value Calculator

INTRODUCTION

Contents Introduction Basic Model-Assumptions Basic Model-Calculations Complex Model-Assumptions Complex Model-Calculations

This sheet Inputs for basic LTV model Output report for basic LTV model Inputs for complex LTV model Outputs for complex LTV model

Overview The LVC tool is designed to let the user estimate the cost of acquiring a customer and the NPV of that customers business during his useful economic life. Two models are offered a simple one that looks at a single product and somewhat simplified assumptions, and a more complex model that allows the user to examine multiple products with distinct customer loyalty and repurchase characteristics. The models assume that customer acquisition is done through a spending program that could include advertisements, special discount coupons or giving out of free samples. The user must make some assumptions about how much it costs the company to reach each potential customer as well as what percentage of customers reached will make an initial purchase. If there are additional costs (such as a rebate) that only apply to actual customers, those are also calculated. This provides a total cost per acquired customer. The customer value calculation is similar to a perpetuity function. At each potential repurchase period, the user must estimate how many existing customers will continue to buy, a percentage known as Retention Rate. After adjusting for price inflation, this gives us all the components we need for the perpetuity formula. In the simple model the customer is considered to have an infinite economic life, although this is not too great a distortion unless retention rates are extremely high. (Even at 80% retention, a customer is almost 90% used up after just ten years.) In the complex model, the user can assign a specific useful economic life to a customer, set multiple retention rates for different years, and look at the value of a customer for a company with multiple products. The calculation page then separates the profitability of the customer on an annual basis and by product, as well as breaking up customer present value by product.

Directions For more detailed directions place your mouse above the red celltips located throughout the tool. See this example --> You may want to print these directions as a reference guide for this tool. You can do this by selecting Print Sheet with Celltips from the HBS Menu To start using the tool, remove the sample data from the tool using the Show/Hide Sample Data option under the HBS Menu

Note About Using Internet Explorer The default setting in Internet Explorer is to open these tools in the Explorer application instead of Excel. We recommend against this and provide directions in the Help section of the HBS Toolkit web site to change this default behavior.

HBS Menu Show/Hide Sample Data: Show Calculator: Show/Hide Celltips: Print Sheet with Celltips: Set Zoom: Visit Web Links: About HBS Toolkit:

Displays or removes sample entries Launches Windows calculator Toggles in/out red Celltips in documented cells Prints Celltip documentation on current sheet Provides quick access to 80%, 100%, and 125% zoom levels Links to HBS Toolkit website, Toolkit Glossary, and Toolkit Feedback, as well as HBS and HBS Publishing web sites Launches the about box for the HBS Toolkit

Jon B. DeFriese MBA `00 and Chad Ellis, MBA `98 developed this software under the supervision of Professor Steven Wheelwright as the basis for class discussion rather than to illustrate either the effective or ineffective handling of an administrative situation.
Copyright 1999 President and Fellows of Harvard College

Lifetime Customer Value Calculator

BASIC MODEL ASSUMPTIONS

Assumptions Time between purchases (years) Retention Rate per Period Average Purchase Value Profit Margin Profit per Purchase Discount Rate per year Product Inflation per year Cost of Reaching a Potential Customer Response Rate Cost of Attracting a Customer Coupon or other one-off costs Total Customer Acquisition Cost

$ $

3 80% 50.00 25% 12.50 12% 3% 0.50 10% 5.00 8.00 13.00

$ $ $ $

Copyright 1999 President and Fellows of Harvard College

Lifetime Customer Value Calculator

BASIC MODEL CALCULATIONS

Calculations Years per Period Retention Rate Inflation per Year Discount Rate per Year Change in value of customer purchase per period Discount Rate per Period Net Present Value of Customer Purchase Stream Cost of Acquiring a Customer Net Present Value of Acquiring a Customer $ $ $ 3 80% 3% 12% -13% 40% 23.55 13.00 10.55

Copyright 1999 President and Fellows of Harvard College

Lifetime Customer Value Calculator

COMPLEX MODEL ASSUMPTIONS

Years of Customer Life Annual Discount Rate

12% Item 1 100.00 $ 3% 20% 75% 60% 3 Item 2 30.00 $ 5% 18% 80% 65% 1 Item 3 50.00 3% 22% 90% 75% 2

Initial Purchase Price Annual Product Inflation Margin per Product Retention Rate Year 1 Retention Rate Later Yrs. Years between Purchase

Copyright 1999 President and Fellows of Harvard College

Lifetime Customer Value Calculator

COMPLEX MODEL CALCULATIONS

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

$ $ $ $ $ $ $ $

Value of Purchase Item 1 Item 2 100.00 $ 30.00 $ 31.50 $ 33.08 109.27 $ 34.73 $ 36.47 $ 38.29 119.41 $ 40.20 $ 42.21

$ $ $ $ $ $ $ $

Item 3 50.00 53.05 56.28 59.70 -

Margin of Purchase Item 1 Item 2 Item 3 20% 18% 22% 20% 18% 22% 20% 18% 22% 20% 18% 22% 20% 18% 22% 20% 18% 22% 20% 18% 22% 20% 18% 22%

Item 1 75% 60% 60% 60% 60% 60% 60% 60%

Retention Rate Item 2 Item 3 80% 90% 65% 75% 65% 75% 65% 75% 65% 75% 65% 75% 65% 75% 65% 75%

Item 1 100% 75% 45% 27% 16% 10% 6% 3%

Survival Rate Item 2 100% 80% 52% 34% 22% 14% 9% 6%

Item 3 100% 90% 68% 51% 38% 28% 21% 16%

$ $ $ $ $ $ $ $

Profit per Acquired Customer Item 1 Item 2 Item 3 20.00 $ 5.40 $ 11.00 $ 4.54 $ $ 3.10 $ 7.88 5.90 $ 2.11 $ $ 1.44 $ 4.70 $ 0.98 $ 1.39 $ 0.67 $ 2.81 $ 0.46 $ -

Item 1 $22.24 Total NPV

Net Present Value Item 2 $13.79 $55.39

Item 3 $19.36

Copyright 1999 President and Fellows of Harvard College