CUSTOMER LIFETIME VALUE (CLV) Part 5.

Retention and the Net Present Value (NPV)

Retention is one vitally important factor affecting a company’s profitability. MBNA bank announced that a 5% increase in its retention rate resulted in a 25% increase in profits.   

Most managers instinctively know that the longer a good customer is retained the more the company profits are likely to increase however, and sadly, many managers do not measure the affect of retention rates on profits. The table below measures the increasing margin contribution made based on how long the customer stays with the company.

The figures here are just examples; your basic data will be different. A 10% per year sales increase is used the future value of which is discounted to get the Net Present Value (NPV) (see posting Aug 18) assuming a 6% interest rate and no risk factor.  Usually the 1^st year of activity generates a slightly lower margin on sales because of some one time costs such as credit checking, providing samples, training and so on. The new customer acquisition cost is derived by taking the total marketing expenditures for the period (usually the past year), deducting that part of it devoted to activities with existing customers and dividing the result by the number of new customers – if proof of the value of customer retention is needed then repeat this calculation but divide the cost by the number of new customers, minus those acquired through referrals.. The yearly retention cost is the expenditure on programs for existing customers, divided by the average number of customers over the period.

It should be clear that the worst possible combination is to have a low retention rate and a high acquisition cost. It is not unusual, in some companies, for the acquisition cost to exceed the 1^st year’s margin – clearly companies with high customer acquisition costs must pay particular attention to the retention rate.

The table shows clearly that the longer a customer is retained the more margin contribution he or she makes.

CLV of the average customer based on years with the company
Years	Sales	Sales	Margin			Acquisition	Retention	NPV
	per year	discounted	%	$	Cum	cost	cost
1	1000	1000	48	480	480	100	50	330
2	1100	1037	50	519	999	100	100	799
3	1210	1076	51	549	1548	100	150	1298
4	1331	1119	51	571	2119	100	200	1819
5	1464	1162	51	593	2712	100	250	2362
6	1610	1205	51	615	3327	100	300	2927
7	1772	1251	51	638	3965	100	350	3515
8	1948	1299	51	662	4627	100	400	4127
9	2142	1346	51	686	5313	100	450	4763
10	2357	1398	51	713	6026	100	500	5426

 

Frank Friend  email. friend@ffauk.com

Next posting “The importance of referrals” Sept 5 2008