WEBVTT
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OK, it's time to eat our vegetables, guys.
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Let's walk through the Netflix example,
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let's put some numbers in here and let's do a calculation of customer lifetime value.
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So first let's set some parameters here.
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What's the problem we're working with?
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So Netflix charges about $19.95 per month,
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variable costs are about $1.50 per account per month.
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Marketing spending is about $6 per year.
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Their attrition is only about .5 per month.
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We knew that they have good attrition, or sorry,
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good retention rate at a monthly discount rate of one percent.
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So the difference here is, as you can see,
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we are working on monthly numbers,
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so the discount rate is lower,
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attrition rate is also lower.
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Now, the first things first,
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what is dollar and the gross margin?
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That's going to be
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your subscription rate
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minus the variable costs.
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That gives us about $18.45.
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Your retention spending is going to be $6 over 12.
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So over here we say with marketing spending or money spent to retain the customer is
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$6 per year so on a monthly level it has to be divided by 12 so they get about 50 cents.
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Retention rate is derived from the attrition rate as one minus
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the attrition rate which is.005 because it's .5 percent per month,
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discount rate is one percent, that's.001.
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What happens after that?
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We know this formula by now, CLV = [$M-$R]x[(1+d)/(1+d-r)].
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Repeat after me CLV = [$M-$R]x[(1+d)/(1+d-r)].
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So let's take all the numbers up there and plug it into the formula and see what we get.
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So CLV is going to be M which is $18.45 over here, minus capital R,
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which is retention spending which is 50 cents over here times (1+d) (1+.01),
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same number here minus the retention rate which is.995.
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So what number do we get from here?
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Let's see, CLV is $17.95.
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The short term margin times $67.33 the long term multiplier.
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So if you multiply these two,
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CLV is equal to $1,209.
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So, the lifetime value of a Netflix customer is about $1,209.
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That is a lifetime value of a customer that Netflix acquires.
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So, here is the thing we can do with this formula.
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Let's consider a scenario.
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If Netflix cuts retention spending from $6 to $3 per year,
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they expect attrition will go up by one percent.
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So they're reducing their spending,
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so they're going to get
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higher attrition rates because retention rate is going to go down.
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Should they do it?
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Will the CLV formula help us understand that?
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Let's see. So to decide,
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what do we need to do?
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We need to recalculate CLV under these new assumptions.
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If the new CLV is higher, we should do it.
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So with the new CLV, I mean,
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with lower retention spending and higher attrition rate,
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if the CLV is still higher we should do it,
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otherwise, we should not.
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So let's calculate the new CLV here.
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The only things that are changing are the retention spending which is $3,
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the attrition, which is now one percent.
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So if you work through the formula here,
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we're getting the same margin, $18.45.
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Retention spending is now three over 12 which is 25 cents.
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In the old one, it was 50 cents.
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Now it is 25 cents.
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Retention rate is 99 percent.
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Discount rate is.01.
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So what do we get here if we plug in the numbers into the formula?
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Let's see, you have CLV equals,
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let's do it one more time.
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CLV = [$M-$R]x[(1+d)/(1+d-r)].
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We're going to take the numbers and apply them to the formula here.
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So it's going to be $18.45,
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the margin, minus the new retention spending,
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25 cents, and then here we have the new retention rate.
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So it's going to be $18.20 x 50.5.
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So as you can see here,
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in the old CLV the short term margin was about $17.
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Now, because you've reduced the retention spending,
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your short term margin is higher,
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about $18.20 but then,
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your long term multiplier has gone down from 67 months to 50 months.
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That's a big shift.
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So now by calculating this new product we can see whether that trade off that we have
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made of increasing short term margin and
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reducing long term multiplier makes sense or not.
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So the CLV is now $919.
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It was $1,209 before and now it's $919.
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So what's the decision here?
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The decision is, don't do this.
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Don't reduce the retention spending for Netflix in this case.
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So you can see, by using the CLV formula,
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we can now see the effectiveness of marketing actions
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and we can also get an idea about how much to spend on retention.