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From the 10,000 prospects from Level 1, only 1000 go on to Level 2. So the cost of acquisition for each person who reaches level 2 is 10 cents per Level 2 prospect.
Level 3: Exchange of Opinions – Cost is $5 per Level 3 prospect
The prospective customer investigates the software more carefully, and looks up other purchasers experience on the Internet or checks with their network of colleagues... Say only 1 out of 20 will do this. Since there were 1000 Level 2 prospects, there will only be 50 Level 3 prospects. Then the advertising cost per Level 3 prospect is $2 each. At this stage, the business starts to incur additional costs in handling the Information exchange between the prospect and the business, some of it factual, some of it exploratory. For example the salesperson business side might ask: “What are you planning to use it for?” and the customer might answer “”I want to improve my business through better contact with my customers.” So the business understands something about what the customer is looking for. But there is a cost to that interaction, in this case assume that its $3. So the total cost per Level 3 prospect is now $2 + $3 = $5.
Level 4: The Close – cost is $25 per Level 4 customer, revenue is $125, net margin is $95, and so net profit is $95 less $25 or $70 in net profit per Level 4 customer.
Of the prospects that download the software, 1 out of 5 decides to buy. Since there were 50 Level 3 prospects, there are 10 buyers, so the acquisition cost for each of them is (50x5)/10 which is $25. But at this stage, the software is purchased together with a support contract, generating $125 in revenue and $30 in product cost. For the business this purchase generates a net margin per product sold of $95. But we have to remember to subtract the acquisition cost so the net profit after acquisition costs is $70 per level 4 customer.
Level 5: Mutual Collaboration and Innovation – CLV = $83.50
At the next stage, we must take into account whether or not the customer continues as a customer when the next upgraded software product is available. Suppose that without any effort at retaining customers, 10% of customers buy the upgrade the following year at the same price. The Customer Lifetime Value over 2 years then can be calculated thus:
If $10 per customer is spent to engage with the customer and build trust and convince them to continue to use the software, the result will be to increase the retention rate. Let’s assume that the retention rate rises from 10% to 50%. To see this more clearly I’ve done the calculation for 1000 customers, so you can see the effect of retention rate change.
The increase in the Net Present Value, even after spending the additional cost of $10 per Year 1 customer, is 92.7-76.3=$16.40
Level 6: Honesty Stage – Customer Lifetime Value of $113.80
Over time the customer starts to provide input to the business about what is really needed for the software to contribute to their success. The business begins to invest in creating the software features that satisfy more customers, and the Net Present Value will go up as a higher percentage of customers, say 80% of the Year 2 customers continue to upgrade their software to the latest more useful versions. Let’s assume that the cost to engage with the customers and get their feedback is $5 per customer in Year 3. As before, to calculate this in a way that is easily understood, I’m going to work out the profits and costs for 1000 customers and then bring it back to the Net Present Value for 1 customer.
Level 7 The Stage of "The Best Possible Version"
At this stage, the customer has reached the point of having so much confidence in the business that there are a number of ways in which they can contribute to the business. One is by continuing to be a customer, with a higher retention rate in later years; more profits accrue to the business. Another way is by making referrals for new customers, which brings in an additional profit stream. At this level, the customer and the business share in each others success within a Win/Win relationship where each desires for the other’s success.
Conclusion
By applying marketing math to the building of customer relationships, we can determine if it is worthwhile to spend the additional costs to increase retention rate. While it may be difficult to forecast retention rate, in time, a business is better off by understanding the factors that determine retention rate. Profitable Customer Experience Management must be combined with rigorous cost analysis and revenue projections that are constantly tested against what actually happens. The improved understanding of costs and retention factors can then be knowledgeably applied to increase Customer Lifetime Value.
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