Question

Background Information:

Zappos is reviewing whether it should buy exclusive rights to get premium placement advertising on Facebook. Zappos has recently conducted an advertising test with Facebook in order to determine the effectiveness of Facebook advertising. Zappos has analyzed the Facebook advertising results and determined the profile of people who buy Zappos shoes after seeing the ads on Facebook.

At the launch of the agreement, Zappos is expected to make an upfront payment of $25 million to Facebook. In addition, Zappos would spend an average of $90,000 per day on Facebook advertising for a full year.

In return, Zappos’s brand would be featured exclusively and prominently on many of Facebook’s pages for its target audience for one year. More specifically, Zappos expects to be present on 60% of its Facebook’s targets’ 60 million page views per day. Based on its testing history, Zappos expects 0.25% of every page view at Facebook would result in a visit to its own website for the entire year of this deal. Zappos also finds about .75% of the visitors to its site actually buy shoes and other merchandise.

While the typical retention rate for Zappos customers is over 80%, management believes customers coming from the Facebook site will have a retention rate of only 65%.

The dollar amount of a typical order is $80. Assume average purchase cycle is once per year.

Zappos’ CFO is concerned that, with a 35% gross margin per order and 10% cost of capital, this deal may not be worthwhile.   

Assume customers acquired at the end of the year are worth the same as those acquired at the beginning of the year. Assume a discount rate of 10%.

Question:

An independent marketing research firm sells syndicated marketing research services to a variety of customers. An average corporate customer generates $6,000 in annual profits per year. The firm is considering investing in additional services to improve retention rates from 60% to 70%. Assuming a discount rate of 10%, the margin multiple is 1.20 for a 60% retention rate and 1.75 for a 70% retention rate. If the retention rate was improved from 60% to 70%, which of the following is the estimated difference in the customer lifetime value (CLV) of an average corporate customer?

a)$2,200

b)

$3,300

c)

$7,200

d)

$10,500

e)

$19,700

Answer 1

Answer:

Correct answer is:

b) $3,300

Explanation:

An average corporate customer generates $6,000 in annual profits per year

Assuming a discount rate of 10%, the margin multiple is 1.20 for a 60% retention rate and 1.75 for a 70% retention rate.

The margin multiple factors in both life span and discounting rate.

As such, CLV at 60% retention = $6000 * 1.2 = $7,200

CLV at 70% retention = 6000 * 1.75 = $10,500

Hence, if the retention rate was improved from 60% to 70%, the estimated difference in the customer lifetime value (CLV) of an average corporate customer = 10500 - 7200 = $3,300

As such option b is correct and other options a, c and d are incorrect.