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Extending the CLV Formula, Part 2

Watch Raj Venkatesan explain two other factors that affect CLV calculations: cohort and incubate and contractual vs non-contractual customers.
We’re now going to work with cohort and incubate and contractual versus noncontractual business models and how they relate to the application of CLV. Let’s start with cohort and incubate. So what I have up here is a blank graph, right? On the X-axis, we have time. On the Y-axis, we have retention rate. What do you think is going to happen for retention rate over time? How does retention rate evolve for a customer over time? Is it going to be flatlined like this or is it going to change? Think about it. Is retention rate going to stay flat over time, is it going to increase or decrease over time?
Typically, as we saw even in the Netflix case, retention rates starts increasing and steadying over time. So what this means is retention rate depends on time since customer acquisition. So the more time a customer stays with a firm, the longer their retention rate is going to be and over time it flattens out. So what does this mean for CLV calculations? The main implication is that you have to calculate CLVs among cohorts. And what are cohorts? Customers acquired at the same time period, month, quarter, or year. It’s because if you mix customers who belong to different cohorts, the stage on retention to time graph is going to be different. Then you’re kind of mixing apples and oranges here.
So basically what you need to do is select a cohort and calculate the retention rate for that cohort and the CLV for that cohort, okay? Now let’s look at contractual versus noncontractual businesses.
Xfinity and Netflix have a contract with their customers. So these firms sign a contract with their customers and the customers have to call up these firms to cancel their subscription. What this means is that the firms, like Xfinity and Netflix, know when a customer unsubscribes to their service. This really helps in knowing lifetime duration and retention rate. What if a customer does not have to sign a contract?
There are instances like that. With firms like Kroger, grocery stores, for example, you don’t have to sign a contract with them. You can just happily walk in, buy something, and go home. And then they will know you’re still a customer if you walk back in again. But if somebody doesn’t come back for a long time, that could even mean the customer is just dormant. It doesn’t mean the customer left the relationship, they may come back again. Maybe they went on a vacation. When they’re back from the vacation, boom, they are back in Kroger, who knows? So what does it mean for calculating lifetime duration and retention rate? What this means is you’ll have to use empirical models.
You’ll have to use regression models that we will see in a different module to calculate this retention rate, to use historic data, to predict expected retention rates. So the retention rate calculation is much more complex when you use a noncontractual setting.

You will need to consider two other factors as you determine customer lifetime value: cohort and incubate and contractual vs non-contractual customers. Learn what these terms mean and how to account for them when you determine CLV. Which of these factors comes into play at your company or for a product or service you use?

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