Applying the CLV Formula: Netflix

OK, it’s time to eat our vegetables, guys. Let’s walk through the Netflix example, let’s put some numbers in here and let’s do a calculation of customer lifetime value. So first let’s set some parameters here. What’s the problem we’re working with? So Netflix charges about $19.95 per month, variable costs are about $1.50 per account per month. Marketing spending is about $6 per year. Their attrition is only about .5 per month. We knew that they have good attrition, or sorry, good retention rate at a monthly discount rate of one percent. So the difference here is, as you can see, we are working on monthly numbers, so the discount rate is lower, attrition rate is also lower.

Now, the first things first, what is dollar and the gross margin? That’s going to be your subscription rate minus the variable costs. That gives us about $18.45. Your retention spending is going to be $6 over 12. So over here we say with marketing spending or money spent to retain the customer is $6 per year so on a monthly level it has to be divided by 12 so they get about 50 cents. Retention rate is derived from the attrition rate as one minus the attrition rate which is.005 because it’s .5 percent per month, discount rate is one percent, that’s.001. What happens after that? We know this formula by now, CLV = [$M-$R]x[(1+d)/(1+d-r)]. Repeat after me CLV = [$M-$R]x[(1+d)/(1+d-r)].

So let’s take all the numbers up there and plug it into the formula and see what we get. So CLV is going to be M which is $18.45 over here, minus capital R, which is retention spending which is 50 cents over here times (1+d) (1+.01), same number here minus the retention rate which is.995. So what number do we get from here? Let’s see, CLV is $17.95. The short term margin times $67.33 the long term multiplier. So if you multiply these two, CLV is equal to $1,209. So, the lifetime value of a Netflix customer is about $1,209. That is a lifetime value of a customer that Netflix acquires. So, here is the thing we can do with this formula.

Let’s consider a scenario. If Netflix cuts retention spending from $6 to $3 per year, they expect attrition will go up by one percent. So they’re reducing their spending, so they’re going to get higher attrition rates because retention rate is going to go down. Should they do it? Will the CLV formula help us understand that? Let’s see. So to decide, what do we need to do? We need to recalculate CLV under these new assumptions. If the new CLV is higher, we should do it. So with the new CLV, I mean, with lower retention spending and higher attrition rate, if the CLV is still higher we should do it, otherwise, we should not. So let’s calculate the new CLV here.

The only things that are changing are the retention spending which is $3, the attrition, which is now one percent. So if you work through the formula here, we’re getting the same margin, $18.45. Retention spending is now three over 12 which is 25 cents. In the old one, it was 50 cents. Now it is 25 cents. Retention rate is 99 percent. Discount rate is.01. So what do we get here if we plug in the numbers into the formula? Let’s see, you have CLV equals, let’s do it one more time. CLV = [$M-$R]x[(1+d)/(1+d-r)]. We’re going to take the numbers and apply them to the formula here.

So it’s going to be $18.45, the margin, minus the new retention spending, 25 cents, and then here we have the new retention rate. So it’s going to be $18.20 x 50.5. So as you can see here, in the old CLV the short term margin was about $17. Now, because you’ve reduced the retention spending, your short term margin is higher, about $18.20 but then, your long term multiplier has gone down from 67 months to 50 months. That’s a big shift. So now by calculating this new product we can see whether that trade off that we have made of increasing short term margin and reducing long term multiplier makes sense or not. So the CLV is now $919.

It was $1,209 before and now it’s $919. So what’s the decision here? The decision is, don’t do this. Don’t reduce the retention spending for Netflix in this case. So you can see, by using the CLV formula, we can now see the effectiveness of marketing actions and we can also get an idea about how much to spend on retention.