> Detecon Executive Briefing

Christian Barte Stefan Krämer

Christian.Barte@detecon.com Stefan.Kraemer@detecon.com

Customer Lifetime Value

A management method back
in the limelight in times of
crisis and recession
Defining and managing customer segments based on financial values
is not a new or innovative idea. It has been introduced to many mature
industries as an effective tool to identify a more efficient allocation of
limited company resources to customer segments with the greatest
financial contribution. However, while many telecommunications
operators in more mature markets have already developed and
integrated complex methods of customer segment analytics in their
daily operations, those in less mature markets are yet to close this
gap.

Taking the example of East and Southeast Europe, this Detecon

Executive Briefing points out the reasons, challenges, benefits and
implementation possibilities of the most renowned value based
customer segment management method, customer lifetime value
(CLV), for operators that are inevitably coming into a more mature life
cycle stage.

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The telecommunications environment in East and

Southeast Europe
The East and Southeast European telecommunications industry has changed. Gone are the
days of excessive high growth, profits and cash flow of the early years. Today, the best word
to describe it is “maturity”, or even “saturation”. Maturity means lower technical and
regulatory barriers to market entry, greater competition and commoditization of
existing products and services in a market that no longer grows. As a result, the
availability of “innovative” products and services is no longer the single differentiation factor
between operators in the minds of consumers. Instead the “emotional connection” to a
specific brand is what is likely to keep consumers more attached to a specific operator.

60%
EBITDA margin

50%

40%
-5%
30%

20%

10%

0%
2003 2004 2005 2006 2007 2008
Year
= Telecommunications sector EBITDA margin of one country and year

Fig. 1: Telco sector EBITDA development of 32 European countries between 2003 and 2008 (Reuters)

What does it mean? First, it gives way for new business models and new technical
solutions that often have little to do with the original business of a telecommunications
operator (e.g. big retail chains acting as MVNOs). Second, these new business models are
often leaders in picking up and delivering on the preferences of specific customer segments
and therefore customers become more aware that there is a greater choice for their
particular needs. Third, it leads to more inquisitive and critical customers and thus greater
market segmentation based on more diverging customer preferences.

This is often new for Eastern and Southeastern European operators, who are traditionally
used to operating in a market where there are two or three operators, at most, pursuing more
or less similar strategies. In this type of market, the operator’s primary concern has been for
a long time how to overcome the technical challenges of infrastructure implementation
and maintenance.

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 Customer Lifetime Value
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As a result, little attention has been paid to identifying and servicing the multifaceted
preferences of the market’s user groups and to the value of specific customer segments.

However, with the advent of new technologies and the decrease of regulatory barriers to
entry, new players from within and outside the telecommunications industry have taken the
chance to enter this lucrative market by re-defining the historical segmentation of the
market and by using their often superior marketing power (e.g. low cost MVNOs of major
retailers) to draw customers away from incumbent players.

These significant changes in the Eastern and Southeastern European telecommunications

market will undoubtedly bring new challenges to incumbent operators. Operators there will
have to critically review their current operations and most importantly find ways of answering
the question of “how to allocate company resources to optimize the financial benefits” if
they would like to succeed. One possible method of doing so is through the so called
“Customer Lifetime Value” or CLV method.

The Customer Lifetime Value Method

The customer lifetime value measures the profit (usually EBIT or EBITDA) generated by a
specific customer segment across the entire life cycle. It is calculated by subtracting from the
periodical profits the costs for the initial acquisition, retention and disconnection. For a
European mobile operator's Youth segment the following lifetime value calculation serves as
an example.

Lifetime (4 years)

12 31
61
55
85
55
52
-95
Acquisition y1 y2 Retention y3 y4 Disconnect CLV

Yearly Margins Yearly Margins

Fig. 2: Example for the calculation of the customer lifetime value of the segment “Youth”

It includes all those customers that can be characterized by the following criteria: age 16,
first-time mobile users, high-school students, low income, parental income > EUR 60,000.
The average lifetime for a specific individual of this segment is 4 years. Assuming a 10%
discount rate, the present CLV for this specific individual is EUR 2.30 (EUR 31 non-
discounted).

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With 1.000.000 individuals in this segment, the average “Youth” segment lifetime value is
EUR 2,300,000. The substantial difference in discounted versus non-discounted life-time
value results from the different time value of money between, usually, high initial acquisition
expenses and margins in later years.

Typical results of a CLV analysis

CLV analysis is mostly used to pro-actively drive the value of individual customers or
segments and can lead to CLV related project Internal Rate of Returns (IRR) of up to
25.5% over the course of 2-3 years. A typical CLV analysis is shown below.

Customer A: business Customer C: unprofitable and

1000 manager, CLV of EUR 800: pays late: increase late fees or
defend against competition encourage pre-paid service
800
CLV (in EUR)

600 Customer B: mother of four,

CLV of EUR 200: cross-sell
400 broadband services
200

-200
0% 20% 40% 60% 80% 100%

% of customers
20% of customers constitute 5-7% of customers
50% of total portfolio value have negative CLVs

Fig. 3: Example results of a customer lifetime value analysis for existing wireless customers

Once operators know the CLV, a tactical decision matrix can be set up in order to define
appropriate measures that will increase the value of each individual segment:

Q High CLV, high current profitability: Grow and retain, e.g. provide premium access to
customer care services
Q High CLV, low current profitability: Grow, reduce costs and manage risks, e.g. set
incentives to move to bundled products
Q Low CLV, high current profitability: Maintain relationships and transition to high CLV,
e.g. up- or cross-sell new services such as Internet or IPTV
Q Low CLV, low current profitability: Manage costs and identify transition opportunities,
e.g. provide customer care through a web portal only

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Key implementation challenge

The key challenge for CLV projects is to get relevant input information. Often, the sales
department is in the hands of third party shops that are contractually not obliged to provide
any detailed customer relevant information to operators. Due to this unfavorable lock-in
situation with third party shops, many operators feel that they do not have enough “real
life” information to determine the CLV. However, the example of Western European
operators shows that the inclusion of a specific clause in the contract between an operator
and a third part shop to that effect can resolve this issue.

Recommendation: Practical approach to implementation

The implementation of a CLV project should consider the following aspects:

Q Determine a senior champion in the organization to own the responsibility for the
implementation of the CLV project.
Q Set up a specifically dedicated CLV work team including representatives from
Marketing, Finance and IT to figure out the details of the CLV implementation project.
Q Define a governance model to encourage and streamline both the internal and external
customer interface points and keep track of the behavior of segments.
Q Define the appropriate method of calculation of customer life-time value to be
performed by a service costing system. To understand the origins of profit and loss, both
historical and forward-looking customer life-time values will have to be addressed.
Q Implement a regular reporting pack for sales and marketing to keep track of profit
and loss changes of individual customer segments.
Q Identify lifetime value of segments, define improvement actions for loss-making
segments and re-define the way resources are allocated to these segments in order to
improve resource productivity performance.

Introduce a constant segment value improvement cycle and focus managers’ attention
on segment values by giving them segment value specific performance targets.

Conclusion

As the example of East and Southeast European operators shows, operators in maturing
markets will have to adapt to the changing market conditions. Only those operators that can
find a way of operating more efficiently and quickly will be able to maximize their chances of
long-term prosperity. Although the CLV method is not the only way of achieving it, it is one of
the long-term constant benefit deriving methods, and as the current financial crises
highlights, long-term value is better than chasing short-term gains.

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