Asian Automobiles

In this chapter, we will take you through the computation of lifetime value for an automobile company, which we call Asian. Then we will show you the strategies that arise as a result.

Asian sells automobiles and arranges car leases and loans. The company had 2 million customers on its database. These customers included current owners of new Asian cars, owners of used Asian cars, and Asian leaseholders. The first and most important part of the lifetime value project was determining the repurchase rate of Asian’s customers.

The repurchase rate for automobiles is very complicated. Some people buy a new car every year. Others buy them only every 2, 3, 4, 5, 6, 7, or even more years. Some buy two or more cars. Others buy used cars. Still others buy an Asian, drive it for a while, then sell it and buy some other brand. Then they come back to Asian after a few years. In all of this buying and selling, what is the repurchase rate?

The repurchase rate for automobiles is the percentage of the average group of customers who will buy a new car from the same manufacturer when they turn in their existing vehicle.

The repurchase rate is further complicated by the fact that Asian has many different models of cars, and each model has its own unique repurchase rate.

The goal for any automobile company is to have a repurchase rate of more than 100 percent. How would that be possible? It would occur if customers never died, if they always bought the same brand when they turned in their existing vehicle, and if many of them bought two or more cars. For the automobile industry as a whole, the repurchase rate is about 35 percent. The goal is to determine the repurchase rate for every Asian model and for owners of used Asian cars as well.

To accomplish this, it is necessary to develop some tables from the database that illustrate the situation. Such tables should begin with a particular year, such as 1997. You can then determine what Asian cars the owners of 1997 models owned in the summer of 2002. Next, you create the same tables for the owners of 1998, 1999, 2000, and 2001 models. Finally, you have to create similar tables for Certified Previously Owned (CPO) Asian cars—Asian cars that were bought used. These data are usually available because manufacturers require their dealers to report the owners of each new and each used Asian. This information is stored in Asian’s database. Table 4-1 shows what the 1997 Asian owners owned in the year 2002.

Table 4-1: Changes in Ownership over the Years

Chart A	Totals	A Model	B Model	C Model	D Model	E Model
Owned 1997	120,409	17,472	53,259	26,784	17,646	452
Owned 2002	91,875	14,133	38,950	19,585	14,111	339
Bought new	30,295	4,003	11,666	7,861	6,619	146
A Model	9,491	980	6,221	1,464	802	24
B Model	3,735	1,729	1,040	565	382	20
C Model	8,491	651	3,047	3,924	844	26
D Model	6,684	396	838	1,267	4,126	57
E Model	1,893	247	521	641	466	19
Repurchase rate	25%	23%	22%	29%	38%	32%

From these data, one would assume that the repurchase rate varied from 22 to 38 percent, but that is not the case. To get the real repurchase rates, you have to figure in the Asian owners who bought cars every year, every 2 years, and so on. The numbers shown in Table 4-1 mask the fact that in the 5 years between 1997 and 2002, a significant number of people bought two, three, or more new cars from the company and resold them, and many purchased multiple vehicles and kept them. Dozens of charts are needed to measure and account for the varying behavior of customers. Overall, the picture that emerged was of the average Asian customer buying a new car every 3 years because of the expiration of the lease and loan arrangements. The raw numbers have to be converted into adjusted numbers as shown in Table 4-2.

Table 4-2: Adjusted Repurchase Rates

	Totals		A Model	B Model	C Model	D Model	E Model
Raw Totals
1997	25.16%		22.91%	21.90%	29.35%	37.51%	32.28%
1998	24.00%		16.00%	23.00%	26.00%	35.00%	17.00%
1999	16.00%		11.00%	16.00%	14.00%	23.00%	20.00%
2000	7.00%		5.00%	6.00%	6.00%	8.00%	20.00%
2001	4.00%		4.00%	3.00%	4.00%	5.00%	20.00%
Adjusted Totals
1997	0.33	7.90%	7.40%	6.00%	11.00%	12.70%	10.90%
1998	0.5	11.50%	8.20%	11.30%	13.10%	17.40%	8.50%
1999	1	15.80%	10.90%	16.10%	14.10%	22.60%	20.00%
2000	1	7.00%	5.20%	5.60%	6.40%	8.00%	20.00%
2001	2	7.90%	7.20%	6.10%	7.10%	9.90%	40.00%
Total	5	0.10%	39.00%	45.20%	51.60%	70.60%	71.00%

Putting the numbers from all years together gives us the results shown in Table 4-3. From Table 4-3, we are able to go on to compute the automobile owners’ lifetime value. The lifetime value chart for the B Model is shown in Table 4-4.

Table 4-3: Final Repurchase Rates

	Totals	A Model	B Model	C Model	D Model	E Model
Repurchase rates	50.10%	39.00%	45.20%	51.60%	70.60%	71.00%

Table 4-4 needs some explanation. In the first place, the data showed that the repurchase rate tended to go up for long-term Asian car owners. Long-term owners tend to be more loyal than newer owners. The $4000 profit per car is the profit to Asian, not the profit to the Asian dealer. Asian is actually selling cars to dealers, not to the general public. The acquisition cost per car was the amount per car that Asian spent on co-op ads and other promotions. Each dealer, of course, had its own advertising and promotion costs, which are not reflected in these numbers. The marketing costs ($20 per customer per year) are the amounts that Asian spent annually on the database and on communications with customers. This is a high number. Many car companies spend only a fraction of this amount on marketing to existing customers.

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Table 4-4: Lifetime Value

B Model cars	Years 1–3	Years 4–6	Years 7–9
Revenue
Repurchase rate	45.20%	47.40%	51.20%
Customers	264,124	119,384	56,588
Net profit per car	$4,000	$4,000	$4,000
Net revenue	$1,056,496,000	$477,536,192	$226,352,155
Costs
Acquisition cost per car	$400	$300	$275
Acquisition cost	$105,649,600	$ 35,815,214	$ 15,561,711
Marketing costs ($20/yr)	$ 5,282,480	$ 2,387,681	$ 1,131,761
Total marketing and sales	$110,932,080	$ 38,202,895	$ 16,693,471
Profit	$945,563,920	$ 439,333,297	$ 209,658,684
Discount rate	1.11	1.31	1.54
NPV of profit	$851,859,387	$ 335,368,929	$ 136,142,002
Cumulative NPV of profit	$851,859,387	$1,187,228,316	$1,323,370,318
Lifetime value	$3,225.23	$44,94.97	$50,10.41

The profit is equal to the revenue less the costs. This profit has to be discounted to reflect the net present value of the funds involved.

The net present value is the current (today’s) value of money that you are going to receive in the future, as $1000 to be received a year from now is not worth as much as $1000 received today. To compute the value of $1000 to be received a year from now, you have to discount it by an amount that reflects the cost of waiting. Waiting has a cost, because if you had the $1000 now, you could invest it and receive a return. By waiting, you forgo that return. We discount all future profits in a lifetime value chart to produce net present value. The numbers behind Table 4-4 are shown in Table 4-5.

Table 4-5: Discount Rate Conversions

Factor	Rate
Time delay 1–3 years	2.0
Time delay 4–6 years	5.0
Time delay 7–9 years	8.0
Risk factor	1.20
Cost of capital	4.6%

The discount rate reflects the fact that for Asian, automobile sales are a business-to-business transaction between Asian and its dealers. See Chapter 2 for the formula for the discount rates.

Finally, of course, the lifetime value of a customer is derived by dividing the cumulative net present value number in each of the three time periods by the original 264,124 customers. What we are computing is the lifetime value of these 264,124 customers. Table 4-4 tells us that the value of a newly acquired customer to Asian is $5010 in the ninth year.

What You Can Do with the Numbers

Knowing what the lifetime value of a customer will be 9 years from now is not very valuable unless you can use that number to drive marketing strategy in some way that will increase company profits. That is exactly what we are going to do. Let’s look again at the repurchase rate by model (see Table 4-3).

The average Asian repurchase rate is about 50 percent, but the repurchase rate for B Model cars is only 45.2 percent. The B Model is Asian’s most popular car. Suppose the repurchase rate for this car could be raised so that it was equal to the average repurchase rate for all Asian cars, namely 50 percent. This is certainly an achievable goal. If it were to be reached, what would it do for Asian’s profits? We can calculate that by making two assumptions:

1. We can come up with strategies that raise the repurchase rate of this model of car.

2. The strategies will succeed in bringing the repurchase rate up to 50 percent, or about even with the repurchase rate for the average Asian car.

What might these strategies be? There are many things that Asian might offer its customers:

• A welcome kit inviting new owners to come to a Web site to update their profile and to provide an email address for future correspondence

• Regular communications about the car, including service requirements

• A car birthday card

• An Asian magazine for new-car owners only

• Invitations to events sponsored by Asian, including skiing and yachting excursions, golf tournaments, and fashion shows

• Special preview information for owners on new Asian models and features

• A customer service call twice a year:

  “Welcome, Arthur. I am Jennifer, your personal Asian customer service representative. I am here to make your B Model ownership a wonderful experience. Here is my personal phone number. Call me whenever you need assistance of any kind. You can reach me at any time. I am here to help.”

  What could Jennifer do?

  • She could provide the owner with the distance and directions to the nearest gasoline station, hotel, restaurant, or hospital.

  • She could call the police, when needed, or provide emergency road service.

  • She could help to locate cars that have been stolen or that have been lost in a vast airport parking lot.

  • She could locate the nearest Asian dealer and schedule service.

  • She could communicate with the owner by email, sending birthday cards and service reminders.

In other words, it is possible to make owning an Asian B Model so attractive that enough owners will want the same model next time to make the repurchase rate climb from 45 percent to 50 percent. Let’s say that the cost of these additional services would be $30 per car per year. Putting that increase into the calculations, Table 4-6 shows what would happen to B Model lifetime value. Comparing before and after, we have increased Asian’s profits by $56 million over 9 years, as shown in Table 4-7.

Table 4-6: Lifetime Value after Retention Programs

New LTV	Years 1–3	Years 4–6	Years 7–9
Revenue
Repurchase rate	50.00%	53.00%	56.00%
Customers	264,124	132,062	69,993
Net profit per car	$4,000	$4,000	$4,000
Net revenue	$1,056,496,000	$528,248,000	$279,971,440
Costs
Acquisition cost per car	$400	$300	$275
Acquisition cost	$105,649,600	$39,618,600	$19,248,037
Marketing costs ($50/yr)	$ 13,206,200	$6,603,100	$3,499,643
Total marketing & sales	$118,855,800	$46,221,700	$22,747,680
Profit	$937,640,200	$482,026,300	$257,223,761
Discount rate	1.11	1.31	1.54
NPV of profit	$844,720,901	$367,959,008	$167,028,416
Cumulative NPV of profit	$844,720,901	$1,212,679,909	$1,379,708,324
Lifetime value	$3,198.20	$4,591.33	$5,223.71

Table 4-7: LTV Gain

	Years 1–3	Years 4–6	Years 7–9
New lifetime value	$3,198.20	$4,591.33	$5,223.71
Previous lifetime value	$3,225.23	$4,494.97	$5,010.41
Difference	($27.03)	$96.36	$213.30
Times 264,124 customers	($7,138,486)	$25,451,592	$56,338,006

Let’s see just what this $56 million profit means. If you look at years 1 through 3, you will see a loss of $7 million. The loss comes about, of course, because we are spending $30 more per customer per year to build and maintain a profitable relationship with Asian’s customers. These improved relationships will not show up until the 3 years are over and Asian’s customers make a decision on their next new car. Without a long-range plan, few car companies would be willing to stand for a $7 million loss in the first 3 years. Numbers like this are the reason why database marketing is such a hard sell for all but the most established and forward-thinking companies. But the $56 million profit is real. It includes all costs, and it absorbs the $7 million loss in the first 3 years. As we shall see later, this $7 million loss is not real. It is offset by gains from buyers who get a new car every 1 or 2 years.

Buying a Car Every Year

Relationship building does not need to stop with moving the B Model repurchase rate up to 50 percent. In fact, there is much more that you could do with the lifetime value analysis in this situation.

The tables given so far have assumed that the average Asian customer buys or leases a new car every 3 years—and, in fact, that is the case. What it ignores, however, is the fact that there are a substantial number of Asian customers who buy new cars every year or every 2 years. What will be the impact of the retention-building programs on these people? Detailed studies of the Asian database showed the following:

• Six percent of Asian B Model owners bought a new car every year.

• Six percent of Asian B Model owners bought a new car every 2 years.

• The overall increase in sales due to the new program will affect not just the third-year totals, but the interim-year totals as well, because your communication strategies will affect these 1- and 2-year buyers and get them to improve their repurchase rates.

There is an extra 1.2 percent increase in sales in addition to the overall 5 percent increase (from 45 to 50 percent), for a total increase of 6.2 percent. Plugging that 6.2 percent increase into the tables raises the $56 million to $73 million. But that’s not all.

Automobile Financing

In the LTV analysis, it is also necessary to consider automobile financing. Like most car companies, Asian runs an automobile leasing and finance business as well. This is a profitable business for Asian. If we are going to increase the repurchase rate of Asian automobiles, we will also automatically increase the profits from leases and financing. To see how this is calculated, let’s look at a baseline automobile leasing lifetime value table (see Table 4-8).

Table 4-8: Car Leasing LTV

Revenue	Years 1–3	Years 4–6	Years 7–9
Repurchase rate	45.20%	47.90%	49.90%
Refinance rate	62.00%	64.00%	66.00%
Retention rate	28.00%	30.70%	32.90%
Customers	100,000	28,000	8,596
Amount financed by lease	$30,000	$32,000	$34,000
Total amount financed	$3,000,000,000	$896,000,000	$292,264,000
Income before taxes	$1,452.22	$1,582.92	$1,725.38
Total income before taxes	$145,222,000	$44,321,754	$14,831,389
Costs
Acquisition cost	$ 6,000,000	$ 1,680,000	$ 515,760
Marketing costs ($12)	$ 1,200,000	$ 336,000	$ 103,152
Total marketing & sales	$ 7,200,000	$ 2,016,000	$ 618,912
Profit	$138,022,000	$ 42,305,754	$ 14,212,477
Discount rate	1	1.33	1.64
NPV of profit	$138,022,000	$ 31,808,838	$ 8,666,144
Cumulative NPV of profit	$138,022,000	$169,830,838	$178,496,982
Lifetime value	$1,380.22	$1,698.31	$1,784.97

There are some interesting new rows on this table. Asian does not get to finance every Asian car that is sold, of course. The financing really depends on the market at the particular dealership. There are hundreds of banks and finance companies in the auto leasing and loan business. Asian will get the financing only if it has a good offer and the dealer pushes the sale. Asian has determined that it gets the financing in only 62 percent of the new car purchases. For that reason, a repurchase rate of 45.2 percent of cars translates into a 28 percent retention rate for leases or loans.

To get the dealers to insist on Asian financing, Asian has to make it worth their while. It does this by paying the dealer a premium of $60 per lease or loan as a commission. That is shown here as the lease acquisition cost. In addition, Asian contacts its customers with a welcome kit and other communications to ensure that customers appreciate the value of Asian financing and will use Asian again when the time comes. Asian spends $12 per customer every 3 years on communications to improve the customer retention rate.

automobile sales, the discount rate is based on a business-to-business sale of cars to dealers, in which the manufacturer sometimes has to wait for the dealer to pay. With automobile financing, the discount rate is based on business-to-consumer financing. The payments by the consumers are immediate (unless some promotion is involved), so the waiting period is less, but the risk factor is slightly higher.

The final result is that each new customer who buys an Asian automobile and finances it with Asian returns about $1785 to Asian over 9 years in the form of profit from financing. What will happen to that financing profit if Asian does boost the repurchase rate of B Model cars from 45.2 percent to 51.2 percent (adding the growth from sales during the 3-year period to the growth to 50 percent)? The results are shown in Table 4-9. The net increase in long-term profit to Asian is almost $7 million over 9 years (see Table 4-10). And Asian did not have to do anything unusual to get this increase.

Table 4-9: Improved Lease LTV

Revenue	Years 1–3	Years 4–6	Years 7–9
Repurchase rate	51.20%	54.20%	57.20%
Refinance rate	62.00%	64.00%	66.00%
Retention rate	31.74%	34.69%	37.75%
Customers	100,000	31,744	11,011
Amount financed by lease	$30,000	$32,000	$34,000
Total amount financed	$3,000,000,000	$1,015,808,000	$374,386,196
Income before taxes	$1,452.22	$1,582.92	$1,725.38
Total income before taxes	$145,222,000	$50,248,206	$18,998,807
Costs
Acquisition cost	$ 6,000,000	$ 1,904,640	$ 660,682
Marketing costs ($12)	$ 1,200,000	$ 380,928	$ 132,136
Total marketing & sales	$ 7,200,000	$ 2,285,568	$ 792,818
Profit	$138,022,000	$ 47,962,638	$ 18,205,989
Discount rate	1	1.33	1.64
NPV of profit	$138,022,000	$ 36,062,134	$ 11,101,213
Cumulative NPV of profit	$138,022,000	$174,084,134	$185,185,347
Lifetime value	$1,380.22	$1,740.84	$1,851.85

Table 4-10: Lease LTV Gain

Improvement in LTV	Years 1–3	Years 4–6	Years 7–9
New LTV	$1,380.22	$1,740.84	$1,851.85
Previous LTV	$1,380.22	$1,698.31	$1,784.97
Difference	$0.00	$42.53	$66.88
Times 100,000 customers	$0.00	$4,253,296	$6,688,364

Adding the profits from the sales of new cars to the profits from the financing, the total profit from the relationship-building program should come to approximately $80 million ($73 million plus $7 million) over 9 years. This is the way lifetime value is used to determine the value of relationship-building programs.

That is not the end of the lifetime value story for Asian, however.

Used-Car Owners Buy New Cars

The repurchase data developed for Asian produced some unanticipated results concerning Asian used-car owners. Many car companies do not consider the LTV of used-car owners in their marketing programs. The conventional wisdom concerning used-car owners is that they do not represent a value to the manufacturer. After all, the manufacturer made its profit when the car was originally sold to the dealer. When the car returns to the dealer as a trade-in, the dealer makes the profit on the resale of the vehicle. When you look at the performance of owners of used Asian cars, however, you find something very interesting (see Table 4-11).

Table 4-11: New-Car Purchases by Used-Car Owners

Used Asian Owned in 1997
	Totals	A Model	B Model	C Model	D Model	E Model
Owned in 1997	63,761	32,777	3,691	16,065	10,545	684
Asian bought by 2002	6,275	2,558	828	1,759	1,111	19
New A Model	2,467	1,670	173	372	236	16
New B Model	801	242	295	149	107	9
New C Model	1,642	583	73	692	265	29
New D Model	1,094	132	53	166	705	39
New E Model	475	147	41	147	120	19

This table shows just one year. As you can see, 6275 of the owners of used Asian cars in 1997 bought new Asian cars by 2002. Similar charts were developed for each year. Putting them together, the final result was that in the average year, 6400 owners of Asian used cars purchased a brand new Asian. The owners of Asian used cars were, in fact, the greatest single prospect group for the purchase of new vehicles other than new Asian car owners.

Lifetime value is forward-looking. It does not deal with the past. We are asking, “How much profit will you make from these people over a period of time?” When you ask the question this way, it is clear that used-car owners have a lifetime value for Asian. We calculated the number of Asian cars that typical Asian car owners were buying each year. By knowing the profit to Asian from the cars they were buying, it was possible to calculate the lifetime value to Asian of owners of used Asian cars, which is shown in Table 4-12.

Table 4-12: LTV of Used-Car Owners

	Years 1–3	Years 4–6	Years 7–9
Revenue
Repurchase rate	51.20%	54.20%	57.20%
Customers	6400	3277	1776
Net profit per car	$4000	$4000	$4000
Net revenue	$25,600,000	$13,107,200	$7,104,102
Costs
Acquisition cost per car	$200	$200	$200
Acquisition cost	$1,280,000	$655,360	$355,205
Marketing costs ($50/yr)	$ 320,000	$163,840	$ 88,801
Total marketing & sales	$1,600,000	$819,200	$444,006
Profit	$24,000,000	$12,288,000	$ 6,660,096
Discount rate	1.11	1.31	1.54
NPV of profit	$21,621,622	$ 9,380,153	$ 4,324,738
Cumulative NPV of profit	$21,621,622	$31,001,774	$35,326,512
Lifetime value	$3378.38	$4844.03	$8831.63

This shows that the owner of a used Asian car has a lifetime value to Asian of $8832 over 9 years. What can you do with this information? You can use it to calculate the value to Asian of programs designed to increase purchases of used Asian vehicles by members of the general public. A program that was previously considered to be something that would help the Asian dealers is actually profitable for the manufacturer and probably deserves more effort than has previously been expended on it.