# Calculating LTV by Segments

## Calculating LTV by Segments

Calculating LTV for customers as a whole is useful. Calculating the LTV of customer segments is even more useful. An automobile company may find that the LTV of various models may be quite different, as shown in Chapter 4. Two factors, in general, are responsible for the difference:

1. The manufacturer’s profit per car

2. The repurchase rate

With that knowledge, it is possible to determine the additional total profit that a company would earn if the repurchase rate could be modified by changing the behavior of customers. This knowledge can lead to the development of marketing programs aimed at particular customer segments.

## Increasing the Retention Rate

All the factors in a lifetime value table can be influenced by marketing programs: the average order size , the number of orders per year, and the retention rate. To see the way this works, let’s focus on only one factor, the retention rate, and see what would happen if WardChem could increase that rate by 5 percent—an achievable goal for most companies. Let’s see how WardChem could go about it.

• It could set up a relationship-building team for its top customers.

• It could provide a much higher level of customer service.

• It could set up a super-customized Web page for each customer.

• It could put thousands of pages of technical information about its chemicals on the Web for its customers (only) to use.

Let’s assume that the cost of all these additional relationship-building activities is about \$110 per customer per year, or about \$5 million. There could be two results: The retention rate might go up by 5 percent, and the number of orders might go up by one-half order per year. Table 5-8 shows what could happen.

Table 5-8 : Revised Lifetime Value

Year 1

Year 2

Year 3

Retention rate

75%

80%

85%

Retained customers

45,000

33,750

27,000

Average order

\$2,500

\$2,700

\$2,900

Orders per year

8.5

9.5

10.5

Total revenue

\$956,250,000

\$865,687,500

\$822,150,000

Cost rate

75%

71%

69%

Variable costs

\$717,187,500

\$614,638,125

\$567,283,500

Acquisition cost (\$1,400)

\$ 63,000,000

Retention costs (\$200/yr)

\$ 9,000,000

\$ 6,750,000

\$ 5,400,000

Total costs

\$789,187,500

\$621,388,125

\$572,683,500

Gross profit

\$167,062,500

\$244,299,375

\$249,466,500

Discount rate

1.01

1.09

1.17

Net present value of profit

\$164,767,265

\$223,953,322

\$212,564,425

Cumulative NPV of profit

\$164,767,265

\$388,720,586

\$601,285,011

\$3,661

\$8,638

\$13,362

Lifetime value in the third year has gone up from \$11,907 to \$13,362. What does that mean for WardChem in terms of profits? As Table 5-9 shows, it means more than \$65 million more profits—after taking into account the extra \$5 million per year spent on relationship-building activities.

Table 5-9 : Gains through Retention-Building Activities

Year 1

Year 2

Year 3

New LTV

\$3,661

\$8,638

\$13,362

Old LTV

\$3,462

\$7,926

\$11,907

Difference

\$200

\$712

\$1,454

Times 45,000 customers

\$8,987,305

\$32,046,283

\$65,451,072

Lifetime value charts like these are used in calculating the value of a name . They are very powerful predictors of success in database marketing.

## The Value of an Email Name

A name and address with the matching email name and permission to use it can be a very valuable commodity—much more valuable than a simple name and address. There are many reasons why this is so:

• It is far cheaper to send email communications than direct-mail communications, so you save money on each communication.

• Since emails are so cheap and so fast, you can undertake many communications that you simply could not do at all with direct mail.

• Using emails, you can build close relationships that you could not build if you were limited to direct mail or phone. As a result, the email will increase the retention rate of certain customers, which adds directly to their lifetime value.

• Emails can be used in viral marketing. What this means is that you can get customers to write to one another and pass your message to other people whom you don’t know.

• The speed of emails permits you to send types of messages that could not be sent by any other medium. Airlines, for example, send weekly messages about the availability of unsold seats at rock-bottom prices. These messages could not be sent by mail because of the time issue, or by phone because of the cost and the annoyance factor.

Let’s put all these factors together as shown in Table 5-10 to begin to estimate the value of an email name.

Table 5-10 : Annual Email Name Value

Direct mail value

Email value

Regular promotion

\$0.80

\$1.28

Low-cost item promotion

NA

\$0.32

Last-minute special

NA

\$2.48

Retention messages

\$2.40

\$3.68

Follow-up messages

\$1.20

\$9.12

Viral marketing

NA

\$0.24

\$1.20

\$2.24

Rental value

\$0.42

\$4.20

Total annual value

\$6.02

\$23.56

These numbers are very important, as they lie at the heart of the relationship between modern database marketing and the Web. Let’s discuss each type of promotion in turn .

### Regular Promotions

Message for message, email is cheaper to send. Victoria’s Secret has used email marketing for several years . It has more than 4.5 million customer email names in its database. It outsources its email to Digital Impact. The emails are timed to coincide with Victoria’s Secret catalog distribution. This type of email generates a purchase rate of about 6 percent, according to Shar Van Boskirk of Forrester Research.

Suppose you send regular promotions eight times per year to your customer base. Your response rate might look like Table 5-11. As you can see, the response rate for direct mail is higher than that for email. This will normally, although not always, be true. However, the higher cost of direct mail swamps the improved response rate, giving the profit per name from email a 60 percent lift.

Table 5-11 : Profit per Name from Regular Promotions

Direct mail

Email

Sent

200,000

200,000

Cost for each

\$0.50

\$0.04

Promotion cost

\$100,000

\$8000

Response rate

3.0%

1.0%

Responses

6,000

2,000

Profit per response

\$20.00

\$20.00

Profits

\$120,000

\$40,000

Net profits

\$20,000

\$32,000

Eight promotions per year

\$160,000

\$256,000

Annual profit per name

\$0.80

\$1.28

### Low-Cost Item Promotion

There are many items that you simply cannot profitably promote by direct mail. One example is the Universal Music promotion of music CDs, which sell for about \$20 each. The profit to a company selling a \$20 item directly is probably on the order of \$8 per item. Table 5-12 shows the way the promotion could work out.

Table 5-12: Profit per Name from Low-Cost Item Promotion

Direct mail

Email

Sent

200,000

200,000

Cost for each

\$0.50

\$0.04

Promotion cost

\$100,000

\$8000

Response rate

3.0%

1.0%

Responses

6,000

2,000

Profit per response

\$8.00

\$8.00

Profits

\$48,000

\$16,000

Net profits

–\$52,000

\$8000

Eight promotions per year

NA

\$64,000

Annual profit per name

NA

\$0.32

Using direct mail for this type of promotion is a loser, so no one would attempt it. Each email name, on the other hand, earns a healthy \$0.32 per year. This is found money that comes from having email names.

### Last-Minute Special

Only certain types of companies have last-minute specials. These include airlines, railroads, hotels, rental car companies, cruise lines, and producers of live theater, sporting events, and concerts—any company that sells something that disappears if it is not used. Last-minute specials also apply to retail stores that are having a special sale that comes to an end in a very few days. These promotions cannot be sent by regular mail because it is too slow. Table 5-13 shows what the value looks like.

Table 5-13 : Profit per Name from Last-Minute Special

Direct mail

Email

Sent

NA

200,000

Cost for each

NA

\$0.04

Promotion cost

NA

\$8,000

Response rate

NA

0.5%

Responses

NA

1,000

Profit per response

NA

\$70.00

Profits

NA

\$70,000

Net profits

NA

\$62,000

Profit per name

NA

\$0.31

Fifty promotions per year

NA

\$2.48

The profit from a last-minute special is pure profit. The seats are going empty. It costs very little to let people sit in them. Even at a very low response rate, the profits are substantial, and the annual value of a name is considerable.

### Retention Messages

Every database marketer likes to think up retention messages. What are retention messages? They are such things as birthday cards, anniversary cards, season ’s greetings , thank-you messages, customer surveys, service reminders, quarterly savings summaries, etc. The value of these messages is not in the response, since none is requested or expected. Their value is derived from the fact that they keep customers from defecting by building profitable relationships with them. The profit comes from the increased retention rate and the consequent increased lifetime value.

To understand this, let’s set up a control group that does not get the retention messages. Table 5-14 shows the lifetime value of this group .

Table 5-14 : Control LTV for Women’s Dress Chain Customers

Year 1

Year 2

Year 3

Customers

200,000

80,000

40,000

Retention rate

40%

50%

60%

Visits per year

2

3

4

Amount spent per visit

\$160

\$200

\$220

Revenue

\$64,000,000

\$48,000,000

\$35,200,000

Cost rate

60%

58%

56%

Cost

\$38,400,000

\$27,840,000

\$19,712,000

Acquisition cost (\$170)

\$34,000,000

Direct mail marketing messages @ \$0.50

6

6

6

Marketing costs

\$ 600,000

\$ 6 00,000

\$ 600,000

Total cost

\$73,000,000

\$28,440,000

\$20,312,000

Profit

–\$9,000,000

\$19,560,000

\$14,888,000

Discount rate

1

1.07

1.15

NPV of profit

–\$9,000,000

\$18,246,269

\$12,955,280

Cumulative NPV of profit

–\$9,000,000

\$9,246,269

\$22,201,548

-\$45.00

\$46.23

\$111.01

This represents customers of a women’s dress chain that has several stores. It costs the chain \$170 to acquire women who make two visits to the chain per year, spending an average of \$160 per visit. The chain retains only 40 percent of these women into the second year. Of those retained, 50 percent remain to the third year. For the loyalists who are still shopping at the chain, the number of visits and spending per visit tend to grow. The chain spends \$4.00 per year on direct-mail marketing messages, including seasonal specials. It loses money on women in the first year, but overall it earns a good profit from those who remain , so that the lifetime value of a newly acquired customer after 3 years is \$111. The chain is doing well.

Now we will determine the effect of additional email retention messages on a similar group of women, which we will call the test group. These women get 36 personalized email retention messages per year from the store, in addition to the regular direct mail. These messages cost \$0.04 per message. They have the effect of increasing the retention rate by 5 percent, the number of visits per year by 0.2 visit, and the spending rate per visit by \$5. Table 5-15 shows the results.

Table 5-15 : Improved LTV through Retention Messages

Year 1

Year 2

Year 3

Customers

200,000

88,000

47,520

Retention rate

44%

54%

64%

Visits per year

2.2

3.2

4.2

Amount spent per visit

\$165

\$210

\$240

Revenue

\$72,600,000

\$59,136,000

\$47,900,160

Cost rate

60%

58%

56%

Cost

\$43,560,000

\$34,298,880

\$26,824,090

Acquisition cost (\$170)

\$34,000,000

Direct mail marketing messages @ \$0.50

6

6

6

Marketing costs

\$ 600,000

\$ 600,000

\$ 600,000

Email messages @ \$0.04

36

36

36

Email total

\$ 288,000

\$ 126,720

\$ 68,429

Total cost

\$78,448,000

\$35,025,600

\$27,492,518

Profit

–\$5,848,000

\$24,110,400

\$20,407,642

Discount rate

1.00

1.07

1.15

NPV of profit

–\$5,848,000

\$22,491,045

\$17,758,376

Cumulative NPV of profit

–\$5,848,000

\$16,643,045

\$34,401,421

–\$29.24

\$83.22

\$172.01

As you can see, these retention messages have a dramatic effect on the women’s behavior. Note that we could not have had this effect by simply increasing the number of direct-mail messages, which were costing us about \$0.50 per message. Had we tried that, 36 messages per year would have cost us \$18 per customer, or \$3.6 million per year, which would have seriously eaten into profits. In addition, many of these email messages were quite timely and could not have been sent at all by direct mail. The effect of the email can be seen in Table 5-16. The gain to the chain is \$12 million in pure profit in the third year.

Table 5-16 : Gains through Retention

Year 1

Year 2

Year 3

Control

–\$45.00

\$46.23

\$111.01

Test

–\$29.24

\$83.22

\$172.01

Gain from use of email

\$15.76

\$36.98

\$61.00

With 200,000 customers

\$3,152,000

\$7,396,776

\$12,199,873

Now we can evaluate the retention messages as shown in Table 5-17. As you can see, increases in retention and lifetime value are much more difficult to measure than other direct marketing factors. You have to set up control groups that do not get the retention messages and then see, after a year or so, whether there is a difference in the retention rate and the lifetime value. The only difference between email and direct mail here is that direct mail is probably more effective in building retention than email. A thank-you letter that is printed and mailed means more than a thank-you email. The same might be true of birthday cards and other retention messages. On the face of it, however, it is a lot easier to get management to spring for \$8000 for email birthday cards than for \$100,000 for direct-mail ones. The probability is that emails will be much more widely used as people come to see their value. So the email will probably be the clear winner in retention messages.

Table 5-17 : Name Value from Retention Messages

Direct mail

Email

Sent

200,000

200,000

Cost for each

\$0.50

\$0.04

Promotion cost

\$100,000

\$8,000

Increased retention

0.080%

0.050%

Current LTV

\$111.01

\$111.01

Increased LTV

\$0.80

\$0.50

Total LTV increase

\$160,000

\$100,000

Net profits

\$60,000

\$92,000

Eight messages per year

\$480,000

\$736,000

Annual name value

\$2.40

\$3.68

### Follow-Up Messages

Here is an area where email wins in a walk. When people order something, you follow up with an email confirmation (or a mailed confirmation). When the product is about to be shipped, you email a notice with the tracking number (it is too late to do this by mail). When the product arrives, you send an email survey: Did it arrive OK, and was it to your liking? Here, again, the email wins. The value is measured in customer retention and increased lifetime value, as shown in Table 5-18.

Table 5-18 : Name Value from Follow-Up

Direct mail

Email

Sent

200,000

200,000

Cost for each

\$0.50

\$0.04

Promotion cost

\$100,000

\$8,000

Increased retention

0.01%

0.01%

Current LTV

\$111.01

\$111.01

Increased LTV

\$0.80

\$0.80

Total LTV increase

\$160,000

\$160,000

Net profits

\$60,000

\$152,000

4/12 per year

\$240,000

\$1,824,000

Annual name value

\$1.20

\$9.12

You may be able to send only 4 direct-mail follow-up messages per year, but you can send 12 or more emails, depending on the number of transactions. The effect on retention and LTV from each message would be the same to the customer.

Because of the cost of sending follow-up messages by direct mail, very few companies send such messages. A better comparison than email versus direct mail for follow-up messages would be to test email versus no follow-up at all. The boost in retention can be measured over a period of a year and can be quite substantial.

### Viral Marketing

This is an interesting concept that works only in certain product situations. You can get some customers so excited about some product that they will write to their friends about it. For what kinds of products or situations does viral marketing work?

• Concerts

• Firearms

• Automobiles

• Travel destinations

• Books

• Political candidates

• Health foods

As you can see, the list is long. How does viral marketing work?

As shown in Figure 5-1, you send an email to customers inviting them to invite other customers by entering their names on a microsite (shown in Figure 5-2). This site, which is connected to your database, records the names and suggests messages to be sent to the names. When the customer clicks OK, the messages are sent, and if the recipients of the message click here, they see a microsite inviting them to accept the offer, thus helping both the customer and themselves .

In this case, one email results in the capture of more names and ultimately thousands of other emails, all promoting your product. Viral marketing is unique to email marketing. It cannot be effectively done by direct mail or phone. The name value is shown in Table 5-19.

Table 5-19 : Name Value from Viral Marketing

Direct mail

Email

Sent

NA

200,000

Cost for each

NA

\$0.04

Promotion cost

NA

\$8,000

Response rate

NA

2.0%

Responses

NA

4,000

Emails captured

NA

1.5

Emails sent

NA

6,000

Success rate

NA

8%

Sales @ \$100

NA

480

Sales

NA

\$48,000

Cost per sale

NA

\$16.67

Value of a name

NA

\$0.24

Viral marketing can be used for very inexpensive items or for quite expensive ones. The cost per sale of \$16.67 shown here assumes that the viral messages sent by customers to their friends will have a higher response rate than messages sent to prospects or to customers in general. Viral marketing can be very powerful if it is artfully used.

Email newsletters have become very popular. They save a lot of money. They often get a good response rate. It should be easy for recipients to discontinue them with one click. That is not so easy for the recipients of direct-mail newsletters. Newsletters result in increased retention, sales, and loyalty. They are usually worth the effort if you can put something into them that your customers want to read. The name value is shown in Table 5-20.

Table 5-20 : Name Value from Newsletters

Direct mail

Email

Sent

200,000

200,000

Cost for each

\$0.50

\$0.04

Promotion cost

\$100,000

\$8000

Response rate

2.00%

1.50%

Responses

4,000

3,000

Average sale

\$100.00

\$100.00

Profit per sale

\$40.00

\$40.00

\$160,000

\$120,000

Net profit

\$60,000

\$112,000

Twelve per year

\$240,000

\$448,000

Annual profit per name

\$1.20

\$2.24

### Name Rentals

Of course, when you have a file of opt-in names of customers who have agreed that they will accept promotions from your business partners , there is another valuable use of the email names you have collected. Since you are using your names more effectively, you can assume that others will be doing the same. Emails have caught on. Billions of commercial email messages are being sent every week. There is a massive market for opt-in names. If you can rent your direct-mail names 8 times a year, you can certainly rent your email names 10 times as often, or 80 times per year. The price per thousand email names varies widely and will certainly be very different from the time of writing to the time that you are reading this book. Let’s take a conservative estimate of \$70 per thousand for both direct-mail and email names with permission to use them for partner messages. Table 5-21 shows what you can expect to receive during a year for each name.

Table 5-21 : Value of Name Rental

Rental value

Direct mail

Email

Rentals per year

8

80

CPM

\$70.00

\$70.00

Revenue

\$0.56

\$5.60

Commissions

\$0.14

\$1.40

Net revenue

\$0.42

\$4.20

Let’s summarize again the value of a name in Table 5-22.

Table 5-22 : Total Name Value

Direct mail value

Email value

Regular promotion

\$0.80

\$1.28

Low-cost item promotion

NA

\$0.32

Last-minute special

NA

\$2.48

Retention messages

\$2.40

\$3.68

Follow-up messages

\$1.20

\$9.12

Viral marketing

NA

\$0.24

\$1.20

\$2.24

Rental value

\$0.42

\$4.20

Total annual value

\$6.02

\$23.56

Of course, few, if any, companies can use every one of these marketing methods , but your company can certainly use at least half of them. We can say with some confidence that email names, with permission, are worth at least \$15 to \$20 each to any company. To my knowledge, no company has done this analysis and therefore knows , with any kind of precision, what emails are worth to it. What does that number tell you in terms of marketing strategy? You must collect email names and get permission to use them.

How do you do that? By every means at your disposal:

• Telemarketers must be compensated for capturing these names.

• Every form should be revised to include a space for email names. Don’t wait for the forms to run out. Junk them and print new ones.

• Run contests in which, in order to enter, customers must go on the Web to a microsite and enter an email name and provide permission to use it.

• Be creative. You gain \$10 per year for every email name captured.

• Lenscrafters gives \$10 for each email name provided by customers.

We are in a new millennium , folks, and the rules of the game have changed. Like the invention of catalogs, direct mail, radio, or TV, this new phenomenon , email, has fundamentally changed the nature of marketing, and we must change with it.