Tuscan CLV 3 December 2012 Attn: Joan Beckman From: BUS 419 students Re: Assessing Customer Lifetime Value We are writing to inform you of our assessment of Tuscan Lifestyle’s customer lifetime value. We have conducted extensive market research in order to gain an understanding of the most effective ways to acquire and retain a profitable, loyal customer base. The key question we set out to learn is whether a customer’s initial purchase amount is a predictor of their future purchases. Specifically, we set out to learn whether customers whose initial purchase is greater than or equal to $50 is more valuable over their lifetime than a customer whose initial purchase is less than $50. By answering this main question, Tuscan Lifestyles can be best informed in creating future marketing plans and can therefore reduce costs. We set out to find those subissues that play into Tuscan’s profitability and to identify other information from the case. Based off of our customer lifetime value calculations, it would appear that a customer’s initial purchase does in fact predict future behavior. The average purchase for those whose initial purchases were under $50, remained under $50 in every one of the subsequent 5 years (when adjusted for discount rate). For those with initial purchases over $50, average purchases remained over $50 in every one of the subsequent 5 years. As a result, it would make sense that we treat these two groups of customers differently. This is especially important for Tuscan Lifestyles because the “under $50” group fails to produce a profit at any point in their 5 year customer lifetime. Currently the acquisition cost per customer is by far the single biggest cost. Since the acquisition cost is calculated using the response rate (2.3%), it is important to focus on getting the best customers possible. This means buying the most focused and detailed lists and targeting those consumers that we believe most likely to buy. The retention cost as a flat $6 per year (8 issues at $0.75/issue) is also highly impractical and damaging to the bottom line. A more focused approach, whereby customers with decreased spending are sent less catalogues per year would work to offset losses. The key question is whether a customer’s initial purchase amount is a predictor of their future purchases. Specifically, we set out to learn whether customers with an initial purchase greater than or equal to $50 is more valuable over their lifetime than a customer whose initial purchase is less than $50. By answering this main question, Tuscan Lifestyles can use this key information to guide future marketing plans and therefore, reduce costs. We also hoped to find other subissues and identify other kinds of information from the case. In order to address this question and its underlying topics, we calculated Tuscan’s current customer lifetime values. The cost per prospective customer name ($0.10) along with the cost of sending a catalog ($0.75) amounts to $0.85 per initial catalog sent. Tuscan Lifestyles has an above-average response rate of 2.3%. Acquisition costs were calculated by dividing the total cost of an initial sent catalogue (0.85) by the response rate (0.023), for a total per customer acquisition cost of $36.96. The current profit margin is 42 percent and retention cost per customer per year after initial purchase is $6 ($0.75/catalogue * 8 catalogues/year). Given the
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Tuscan CLV current profit margin, acquisition costs, and retention costs, the customer lifetime values are $1.41 for customers whose first purchase is greater than or equal to $50 and negative $20.91 for those with initial purchases under $50. Findings
Every customer costs the same amount to acquire. At this time, every customer is treated the same in terms of ongoing retention costs, regardless of purchase amounts or silent attrition. Customers with initial purchases greater than or equal to $50 have a positive cumulative profit after year 3. Customers with initial purchases less than $50 still have a negative cumulative profit after year 5. Furthermore, due to a constant retention rate and steep declines in survival rate, the losses are growing from year 2 onwards. Customers with initial purchases greater than or equal to $50 have positive expected profits in every year including initial purchase (up to year 5), whereas customers with initial purchases of less than $50 only result in positive expected profits in years 1 and 2. Customers with initial purchases of $50 or more have a higher survival rate in every year, as compared to those customers with initial purchases totaling less than $50. Customers with initial purchases of less than $50 have increasing margins per purchase after every year. Customers with initial purchases of greater than or equal to $50 have decreasing margins per purchase after each year except year 4 to 5.
The Big Question: Acquiring and retaining customers in order to maximize profitability We set out to determine whether initial purchase amount could be used to predict future purchase behavior. Our customer lifetime value calculations indicate that a customer’s initial purchase does in fact predict future behavior. The average purchase for customers with initial purchases under $50, remained under $50 in every one of the subsequent 5 years (when accounting for discount rate). The same is true for those with initial purchases over $50--their average purchase remained over $50 in every one of the subsequent 5 years. As a result, Tuscan should treat the two groups of customers differently. The “under $50” group fails to produce a profit at any point in their 5 year customer lifetime. Currently the acquisition cost per customer is the biggest cost. The acquisition cost is calculated using the response rate and the cost of an initial catalogue. Both factors can be adjusted in order to reduce the acquisition cost. Buying more focused lists could increase the response rate. Decreasing the cost of initial catalogues would also reduce this number. The retention cost as a flat $6 per year (8 issues at $0.75/issue) is also highly impractical and damaging to the bottom line. Customers with decreased spending should be sent less catalogues per year in order to reduce unnecessary retention costs. It is very practical to treat customers differently based on their past “performance” or profitability. Spending money on customers who are not continuing to spend money is likely a waste. If a company can identify these “deadbeat” customers and reduce associated costs, it can
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Tuscan CLV avoid unnecessary expenses. Since Tuscan faces silent attrition, it cannot be certain that any customer will not return, so the downside is that it may be “burning bridges.” Some customers may be upset that they are no longer receiving catalogues and since Tuscan is a catalogue-order only business, these customers will find it difficult to buy again. Tuscan does have a problem with silent attrition, but it’s a problem that almost every company in the world has. Customers very rarely tell a company that they are no longer a customer, so they cannot know when a certain customer has stopped buying from them for good, and don’t know therefore, when spending money to retain certain customers is futile. There is a solution to this. Tuscan needs to put in place a system to cut down on unnecessary retention costs. An example would be for them to determine when a customer has not made a purchase in the last year and to decrease the number of catalogues sent to them to 4 per year, instead of 8. The retention cost would therefore be reduced to $3. Then after the second year in a row without a purchase, perhaps they only send 1 or 2, and then none after a given amount of time without customer response. This would increase the profit, but a consideration is that this strategy may also negatively affect the survival rate. A real life test of this would be the only way to determine the effects on profit. The point is to slow the allotment of resources to a customer that is nonresponsive without making them feel that they are being forgotten about. After all, they may desire to buy again in the future and appreciate that the catalogues did not stop dead, or they may never want to see your catalogue again and appreciate that it slows to a stop. We recommend Tuscan Lifestyles reevaluate the customer lists that it is buying, and attempt to attain a higher quality list. We realize this may increase the cost of a name however this will help increase the survival rates. At this time, Tuscan uses a very focused target demographic. The current lists may also be to narrow and too specific so that certain valuable consumers are not being targeted. It may be valuable to explore other, potentially more profitable, demographics. It may be a matter of exploring the demographic differences between profitable and unprofitable customers. The cutoff point to divide customers is those who place initial orders of less than $50 in their and those who place initial purchases of greater than or equal to $50. Those who are likely to be less profitable could be targeted with less expensive catalogues in order to reduce associated costs. Email lists may also be a low cost way to target less profitable customers. Recommendations
We recommend that Tuscan Lifestyles rent more focused customer lists based on further analysis of the consumers who respond with purchase. We recommend this because of the losses involved in customers with initial purchases under $50 and the marginal profits of those with initial purchases above $50. Specifically, we see the high cost of acquisition as a major cost in need of immediate reduction. This can be addressed through an increased response rate. We also recommend that Tuscan Lifestyles focus a larger portion of their marketing efforts on those customers who make initial purchases of $50 or more because they create the largest cumulative profit over time. Even after the initial purchase, these customers have generated a larger profit for the company than the other customer’s first 5 years whose purchase was less than $50. In addition, the customers with the larger initial purchase have greater survival rates over each year, as compared to the other customers.
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Tuscan CLV
This allows the company to build more trust in these customers who will come back and shop more often, and at a higher purchasing price. Because of this, we specifically propose that Tuscan Lifestyles should create a special Loyalty Program for these trusted customers. This program will reward these customers with discounts and benefits. By doing this, Tuscan’s survival rates are likely to increase, thus allowing them to increase profitability. We recommend that Tuscan reduce the cost of the catalog for the under $50 customers (ie, smaller catalogues). We also recommend Tuscan Lifestyles to explore options for reducing the cost of printing catalogs in general. Catalogues that target specific customers based on previous purchase tastes may also be beneficial. The initial catalogue cost is another component that plays into the high acquisition cost. Reducing the cost of the initial catalogue may help to reduce this cost. We do not believe, although it is a risk, that response rates will be significantly impacted as a result of a cheaper catalogue. We recommend further research into the differences of those who make initial purchases of under $50. If a demographic difference can be determined, purchasing an email list may be more cost effective for those who tend to make initial purchases below $50 because an email means no catalogue or mailing costs. This demographic group may also be the target of a cheaper and/or smaller initial catalogue. This recommendation is based off of significant losses involved over the lifetime of customers whose initial purchase is less than $50.
Customer Lifetime Value Calculations
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