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Contents
Introduction
Basic Model-Assumptions
Basic Model-Calculations
Complex Model-Assumptions
Complex Model-Calculations
INTRODUCTION
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
HBS Menu
Show/Hide Sample Data:
Show Calculator:
Show/Hide Celltips:
Print Sheet with Celltips:
Set Zoom:
Visit Web Links:
About 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
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
BASIC MODEL
-ASSUMPTIONS
sample1
Page 4
sample1
3
0.8
50
0.25
0.12
0.03
0.5
0.1
8
Page 5
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
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
sample2
0.12
100
0.03
0.2
0.75
0.6
3
Page 8
sample2
30
0.05
0.18
0.8
0.65
1
50
0.03
0.22
0.9
0.75
2
Page 9
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
$
$
$
$
$
$
$
$
Item 1
$22.24
Total NPV
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 3
$19.36
$55.39
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%
$
$
$
$
$
$
$
$