Question

Predatory Lending Inc. sells financial services (high interest micro loans) through independent agents. Good agents generate $2,000 in net revenue in the first year, a figure that grows at 5% annually. Poor agents, on the other hand, produce $1,000 in year one and 20% less revenue each successive year. There is no way to tell in advance whether an agent will be good or bad. In the past, about 40% of new agents have turned out to be good and 60% poor. Of the good agents, 50% are loyal, they tend to like the work and remain with the company with a 90% probability year to year, and 50% are not loyal, they leave Predatory Lending and go to work for a competitor after the first year. Similarly, 80% of the poor agents are loyal (i.e., the competition wouldn’t hire them) and have a 90% probability of staying with the firm year to year and 20% drop out after the first year and go back to school. (For simplicity, assume that revenues from agents that drop out in year one are not discounted.)

Given that recruiting and training costs are $5,000 per new agent:

1. What is the CLV of each of the 4 possible types of agents (good loyal/ non-loyal and bad loyal / non-loyal? (Assume a 10% discount rate)

2. Can Predatory Lending Inc. remain in business given it current operating situation?

Answer 1

a. CLV of each of the 4 possible types of agents

Good loyal

40%*50%*90%*2000*(1.05)/(10%-5%)=

7560

Good Non-loyal

40%*50%*10%*2000=

40

Bad-loyal

60%*80%*90%*1000*(1-0.2)/(10%-(-2%))=

2880

Bad Non-loyal

60%*20%*10%*1000

12

Adding up, the most expected revenue generating capacity of an agent will be

7560+40+2880+12=

10492

b.

Given that recruiting and training costs are $5,000 per new agent:

CLV of $ 10492/ agent exceeds the above cost of $ 5000 by $ 5492

Hence,

Predatory Lending Inc. can remain in business given this current operating situation