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Kumar, 2005
Customer Relationship
Management
A Databased Approach
V. Kumar
Werner J. Reinartz
Instructors Presentation Slides
www.drvkumar.com Copyright Dr. V. Kumar, 2005
Chapter Five
Introduction to Customer Based
Marketing Metrics
www.drvkumar.com Copyright Dr. V. Kumar, 2005
Topics Discussed
Traditional Marketing Metrics
Customer based Marketing Metrics
Minicase: American Airlines
CRM at Work: Amazon
www.drvkumar.com Copyright Dr. V. Kumar, 2005
Marketing Metrics
Marketing Metrics
Traditional
Primary
Customer-based
Market Share Sales Growth
Customer
Acquisition
Customer
Activity
Popular
Customer-based
Strategic
Customer-based
www.drvkumar.com Copyright Dr. V. Kumar, 2005
Traditional and Customer Based
Marketing Metrics
Traditional Marketing Metrics
Market share
Sales Growth
Primary Customer Based metrics
Acquisition rate
Acquisition cost
Retention rate
Survival rate
P (Active)
Lifetime Duration
Win-back rate
Popular Customer Based metrics
Share of Category Requirement
Size of Wallet
Share of Wallet
Expected Share of Wallet
Strategic Customer Based metrics
Past Customer Value
RFM value
Customer Lifetime Value
Customer Equity
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Traditional Marketing Metrics
Market share
Sales Growth
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Market Share (MS)
Share of a firms sales relative to the sales of all firms
across all customers in the given market
Measured in percentage
Calculated either on a monetary or volumetric basis
Market Share (%) of a firm (j) in a category =
Where j = firm, S = sales, ES
j
= sum of sales across all firms in the market
Information source
Numerator: Sales of the local firm available from internal records
Denominator: Category sales from market research reports or competitive intelligence
Evaluation
Common measure of marketing performance, readily computed
Does not give information about how sales are distributed by customer
(

=
J
j
j j
S S
1
100
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Sales Growth
Compares increase or decrease in sales volume or sales
value in a given period to sales volume or value in the previous period
Measured in percentage
Indicates degree of improvement in sales performance between two or more time
periods
Sales growth in period t (%) =
where: j = firm, S
jt
= change in sales in period t from period t-1, S
jt-1
= sales in
period t-1
Information source
Numerator and denominator: from internal records
Evaluation
-Quick indicator of current health of a firm
-Does not give information on which customers grew or which ones did not
| |
1
100

A
jt jt
S S
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Primary Customer Based Metrics
Customer Acquisition Measurements
Acquisition rate
Acquisition cost
Customer Activity Measurements
Average interpurchase time (AIT)
Retention rate
Defection rate
Survival rate
P (Active)
Lifetime Duration
Win-back rate
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Acquisition Rate
Acquisition defined as first purchase or purchasing in the first predefined
period
Acquisition rate (%) = 100*Number of prospects acquired / Number of
prospects targeted
Denotes average probability of acquiring a customer from a population
Always calculated for a group of customers
Typically computed on a campaign-by-campaign basis
Information source
Numerator: From internal records
Denominator: Prospect database and/or market research data
Evaluation
Important metric, but cannot be considered in isolation
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Acquisition Cost
Measured in monetary terms
Acquisition cost ($) = Acquisition spending ($) / Number of prospects
acquired
Precise values for companies targeting prospects through direct mail
Less precise for broadcasted communication
Information source:
Numerator: from internal records
Denominator: from internal records
Evaluation:
Difficult to monitor on a customer by customer basis
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Customer Activity Measurement
Objectives
Managing marketing interventions
Align resource allocation with actual customer to demonstrate how
knowledge of customer activity adds to shareholder value behavior
Key input in customer valuation models such as Net-present Value
(NPV)
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Average Inter-purchase Time (AIT)
Average Inter-purchase Time of a customer
= 1 / Number of purchase incidences from the first purchase
till the current time period
Measured in time periods
Information from sales records
Important for industries where customers buy on a frequent basis
Information source
Sales records
Evaluation:
Easy to calculate, useful for industries where customers make frequent purchases
Firm intervention might be warranted anytime customers fall considerably below their AIT
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Retention and Defection
Retention rate (%) = 100* Number of customers in cohort buying in (t)| buying
in (t-1) / Number of customers in cohort buying in (t-1)
Avg. retention rate (%) = [1 (1/Avg. lifetime duration)]
Avg. Defection rate (%) = 1 Avg. Retention rate
Avg. retention rate (%) = 1 Avg. defection rate
Avg. lifetime duration = [1/ (1- Avg. retention rate
t
)
Assuming constant retention rates, number of retained customers in any
arbitrary period (t+n) = Number of acquired customers in cohort * Retention
rate
(t+n)
Given a retention rate of 75%, variation in defection rate with respect to
customer tenure results in an average lifetime duration of four years
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Retention and Defection-Example
If the average customer lifetime duration of a group of customers is 4 years,
the Average retention rate is 1- (1/4) = 0.75 or 75% per year. i.e., on an
average, 75% of the customers remain customers in the next period
The effect for a cohort of customers over time out of 100 customers who
start in year 1, about 32 are left at the end of year 4
Customers starting at the beginning of year 1: 100
Customers remaining at the end of year 1: 75 (0.75*100)
Customers remaining at the end of year 2: 56.25 (0.75*75)
Customers remaining at the end of year 3: 42.18 (0.75*56.25)
Customers remaining at the end of year 4: 31.64 (0.75*42.18)
Assuming constant retention rates, the number of retained customers at the
end of year 4 is 100*0.754 = 31.64. (Number of acquired customers in cohort *
Retention rate
(t+n)
)
The defection rate is 1-0.75 = 0.25 or 25%
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Variation in Defection rate with respect to
Customer Tenure
0
5
10
15
20
25
30
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Customer tenure (periods)
#

o
f

c
u
s
t
o
m
e
r
s

d
e
f
e
c
t
i
n
g
Plotting entire series of customers that defect each period, shows variation (or
heterogeneity) around the average lifetime duration of 4 years.
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Change in Customer Lifetime Duration
with Retention Rate
0
4
8
12
16
20
50% 55% 60% 65% 70% 75% 80% 85% 90% 95%
Retention rate
A
v
e
r
g
a
e

C
u
s
t
o
m
e
r

L
i
f
e
t
i
m
e

(
p
e
r
i
o
d
s
)
Note: increasing the marginal retention rate is likely to be increasingly expensive
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CRM at Work: Amazon
One of the leaders in implementing customer relationship management
programs on the web
Helped drive both customer acquisition and retention
In 1999 Amazon acquired 11 million new customers, nearly tripling its
number of customers from 1998
Greatest success in customer retention: Repeat customers during the year
accounted for 71% of all sales
Success attributed to attempt to learn about customers and their needs and
then using this information to offer value-added features to them
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Survival Rate
Measured for cohorts of customers
Provides a summary measure of how many customers survived between the
start of the formation of a cohort and any point in time afterwards
Survival rate
t
(%) = 100*Retention rate
t
* Survival rate
t-1
Number of Survivors for period 1 = Survival Rate for Period 1 * number of
customers at the beginning
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Survival Rate Computation-Example
Number of Customers starting at the beginning of year 1: 1,000
Retention rate Survival rate Survivors
Period 1: 0.55 0.55 550
Period 2: 0.62 0.341 341
Period 3: 0.68 0.231 231
Period 4: 0.73 0.169 169
Number of Survivors for period 1 = 0.55 * 1000 = 550
Survival rate for period 2 = Retention rate of period 2 * Survival Rate of
Period 1. Therefore, Survival rate for period 2 = 0.62 * 0.55 = 0.341
(=34.1%)
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Projecting Retention Rates
To forecast non-linear retention rates,
Rr
t
= Rr
c
* (1-exp(-rt))
where: Rr
t
is predicted retention rate for a given future period,
Rr
c
is the retention rate ceiling
r is the coefficient of retention
r = (1/t) * (ln(Rr
c
) ln(Rr
c
Rr
t
))
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Actual and Predicted Retention Rate for a
Credit Card Company
40%
50%
60%
70%
80%
90%
100%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Period
R
e
t
e
n
t
i
o
n

r
a
t
e

(
%
)
Actual
retention rate
Predicted
retention rate
Rrc = 0.95 means that managers believe that the maximum attainable retention rate is 95%
The known retention rate in period 9 is 80% while the one in period 10 is 82%.
The parameter r for period 9 is (1/9)*(ln(0.95)-ln(0.95-0.8)) = 0.205. The r for period 10 is (1/10)*(ln(0.95)-
ln(0.95-0.82)) = 0.198. --for both periods r approximates the value 0.2.
www.drvkumar.com Copyright Dr. V. Kumar, 2005
Actual Retention Pattern of a
Direct Marketing Firm
1.Period
since
acquisition
2.Actual
retention rate
3.Predicted
retention rate
4.Defection
rate%
5.Survival
Rate
6.Expected
Number of
active
customers
7. Number
of
Active
periods
1 32.0% 68.0% 32.0% 2400 2400
2 49.1% 50.9% 15.7% 1178 2357
3 63.2% 36.8% 9.9% 745 2234
4 69.0% 31.0% 6.9% 514 2056
5 72.6% 27.4% 5.0% 373 1865
6 76.7% 23.3% 3.8% 286 1717
7 77.9% 22.1% 3.0% 223 1560
8 78.5% 21.5% 2.3% 175 1400
9 79.0% 21.0% 1.8% 138 1244
10 80.0% 20.0% 1.5% 111 1106
11 79.7% 20.3% 1.2% 88 969
12 79.8% 20.2% 0.9% 70 844
13 79.9% 20.1% 0.7% 56 730
14 79.9% 20.1% 0.6% 45 628
15 80.0% 20.0% 0.5% 36 538
Cohort of 7500 customers at the outset, maximum retention rate is 0.80 and the coefficient of retention
r is 0.5; after period 10, the company retains approximately 80% of customer base
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Customer Lifetime Duration
Average Lifetime duration = Customers retained
t
* Number of periods / N
Where: N = cohort size, t= time period
Differentiate between complete and incomplete information on customer
Complete information - customers first and last purchases are assumed to
be known
Incomplete information- either the time of first purchase, or the time of the
last purchase, or both are unknown

=
T
t 1
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Customer relationships
Contractual (lost-for-good): Lifetime duration is time from the start of
the relationship until the end of the relationship (e.g.: mobile phone
contract)
Noncontractual (always-a-share): Whether customer is active at a
given point in time (e.g.: department store purchase)
One-off purchases
Customer Lifetime Duration (contd.)
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Customer Lifetime Duration when the
Information is Incomplete
Buyer 1
Buyer 2
Buyer 3
Buyer 4
Observation window
Buyer 1: complete information
Buyer 2 : left-censored
Buyer 3: right-censored
Buyer 4: left-and-right-censored
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P (Active)
Probability of a customer being active in time t
P(Active) = T
n
Where, n is the number of purchases in a given period
T is the time of the last purchase (expressed as a fraction of the
observation period)
Non-contractual case
For an advanced application see:
Reinartz, Werner and V. Kumar (2000): On the Profitability of Long-Life Customers in a
Noncontractual Setting: An Empirical Investigation and Implications for Marketing. Journal of
Marketing. 64 (4), October, p. 17-35.
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Estimation of P(Active)-Example
Customer 1
Customer 2
Observation period Holdout period
Month 1 Month 12 Month 8 Month 18
An x indicates that a purchase was made by a customer in that month
To compute the P(Active) of each of the two customers in the 12th month of activity
For Customer 1: T = (8/12) = 0.6667 and n = 4
P(Active)1= (0.6667)4 = 0.197
And for Customer 2: T = (8/12) = 0.6667 and n = 2
P(Active)2= (0.6667)2 = 0.444
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Win-back Rate
Contractual and non-contractual situations
Proportion of the acquired customers in a period who are customers lost in
an earlier period
Indicates either a successful communication of an important change in the
product offering or service or a change in the customer needs
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Minicase: American Airlines
Leading scheduled air carrier running both passenger and
cargo services
Uses Database Marketing for efficient customer acquisition
First to implement a frequent flyer program (AAdvantage)
Purpose:
To induce current members to spend more of their flight dollars with
American Airlines
To efficiently target new prospects and convert patrons of competing
airlines
Strategy: Cooperation with the credit card company American Express
To identify attractive customers who are not American Airlines flyers
Provide attractive offers to these prospects for inducing them to try
American Airlines
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Summary
In the absence of individual customer data, companies used to rely on
traditional marketing metrics like market share and sales growth
Acquisition measurement metrics measure the customer level success of
marketing efforts to acquire new customers
Customer activity metrics track customer activities after the acquisition stage
Lifetime duration is a very important metric in the calculation of the customer
lifetime value and is different in contractual and non-contractual situations