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Calculating Customer Lifetime Value Pega Marketing for Financial Services 7.31

November 2017

Introduction This document describes how Pega Marketing for Financial Services delivers a solution to calculate Customer Lifetime Value (CLV) for current customers. This allows marketers to be more effective by differentiating between customers with the potential to grow with customers that should only be serviced. Marketers can design appropriate action plans to achieve business growth and improve customer satisfaction. By calculating CLV in real time, the application is able to deliver the right solutions while interacting with a customer.

Contents This document covers the following topics:

What is Customer Lifetime Value?

How is CLV calculated?

What is the benefit of CLV?

How is CLV configured?

What is Customer Lifetime Value? As market dynamics change, retail banks look for new ways to improve how they attract, manage, and retain customers. CLV is an excellent tool to help your organization reach strategic objectives, such as increasing share of wallet, improving customer retention, and increasing return on marketing investment.

By activating customer valuation models in your marketing efforts, you can place more emphasis on customer service and long-term retention, rather than on maximizing short-term sales.

The CLV is the discounted value of the future profits that will be generated by an individual customer, discounted over a weighted average cost of capital. For example, a customer that will generate $120, $80, $30, $50, and $10 of profits in the next 5 years will have a CLV of $238, if the discounted factor is 10%.

As these future profits are uncertain, models have to be developed to estimate the future value of customers. These models are based on data analysis techniques, whereas traditionally, companies have had to focus on analyzing historical data.

Pega has developed a model for customer valuation based on research by Haenlein, Kaplan & Beeser to deliver a CLV in a retail banking context.

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How is CLV calculated? The current calculation is based on the Haenlein, Kaplan & Beeser white paper. However, customers can alter and extend this calculation. For more information, see How is CLV configured?.

CLV calculation formula The CLV is the discounted value of the future profits that will be generated by an individual

customer.

The CLV of a customer is a function of the profit “Pi,j,t”. The customer will generate in the future "t" via the product "j".

“Pi,j,t” is unknown because the prediction model is built to derive this future profit based on overall segmentations for the next five years using transition values.

For the identified segment, use percentage CLV value 100 and calculate the change in CLV for the next 5 years using transition values across each segment.

WACC – The Weighted Average Cost of Capital is the discounted rate of returns expected by the bank.

What is the benefit of CLV? There is a significant added value of CLV-based segmentation, at various levels.

Campaign/Offer: At the Campaign level, CLV can help you capture the cross-sell and cannibalization effect.

In marketing strategy, cannibalization refers to a reduction in the sales volume, sales revenue, or market share of one product as a result of the introduction of a new product by the same producer.

There are two main reasons companies do this. First, the company wants to increase its market share and is taking a gamble that introducing the new product will harm other competitors more than the company itself. Second, the company may believe that the new product will sell better than the first, or will sell to a different buyer.

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Example

A credit card campaign/offer:

Campaign or Next-Best-Action

Bob Chris Eliza Fred

Credit Card $100 $150 $150 $200 Current Account $3000 $5000 $10000 Savings Account $2000 CLV $150 $155 $200 $250

CLV can increase predictability in terms of value and ranking and can be used apart from traditional metrics to enhance customer insight.

Added value at campaign level Example

From a traditional product centric point of view: The return of the campaign is computed taking into account only the return generated by the credit card account.

From a CLV point of view: The return on the campaign takes into account the effect on the checking and savings accounts.

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CLV captures cross-sell and cannibalization effects Client Level: CLV can rank our segments in terms of profitability. More generally, a CLV approach can help you optimize marketing campaigns and customer service.

Added value at client level Example

From a product centric point of view:

Segment A = Segment B = Segment C

From a CLV point of view:

Segment A < Segment B < Segment

Segments can be ranked by CLV as a means to rank by profitability.

Accounts Segment A Segment B Segment C Auto Loan $400/yr $400/yr $400/yr Checking Account $1000/yr [cross-sell] $1000/yr New Savings Account -$1000/yr

[cannibalization]

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Added value for marketing campaigns Example

The CLV change allows companies to optimize profits by targeting segment A for campaign 2 and segment B and C for campaign 1 in order of priority.

With the current tools, we will not be able to determine which campaign is most appropriate for the segment B and C.

CLV Segment A CLV Segment B CLV Segment C Campaign 1 $0 $250 $200 Campaign 2 $25 $50 $55

CLV allows for optimizing marketing campaigns by making more profitable decisions.

How CLV configured? The use of CLV in marketing provides more emphasis on customer service and long-term retention rather than on maximizing short-term sales. Pega Marketing for Financial Services allows customers to create their own specialized CLV calculation through strategy generation to optimize CLV benefit. This is implemented via the strategy builder.

Starting the strategy builder To access the strategy builder, launch Pega Marketing and select Intelligence > Strategies > Create > Guide me through it.

1. Enter a Strategy name and a Description.

2. Click Configure to select the Objective.

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3. Within the Configure Objective window, Add Calculate Customer Lifetime Value and click Apply.

4. Next, in the Configure Calculation Method for CLV, there are two options from which you can choose: a Simple CLV calculation which determines CLV by calculating (customer profit) x (years a customer)–(acquisition cost), and the Retail Banking CLV, which is the one that this document focuses on.

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Configuring CLV calculation for retail banking Complete the following steps to configure the CLV calculation for retail banking:

1. Click Add next to Retail Banking and click Apply.

2. Enter a Discount Rate. Pega recommends using the WACC as your discount rate.

3. Add a minimum of 3 classifications. Classifications are groupings or segments of your customers. For example, you may divide up your customers as high value, medium value, and typical clients. Currently, the CLV calculation for retail banking only supports a maximum of 20 classifications. Each classification can be represented as either a segment or as a (sub)strategy. You will need to first create the segment or the strategy rule to reference prior to selecting them.

For more information on creating a strategy rule, see About strategy rules. For information about creating a segment, see the Pega Marketing 7.31 User Guide on the Pega Marketing product page.

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4. Configure each classification. For each classification, enter an Actual CLV, a Budget CLV, and percentages for the probability of transition. The probability of transition represents the percent chance that the customer transitions from their current classification to each of the other classifications. Finally, enter the chance of losing the customer due to customer attrition. The total of the customer attrition rate with all the percentages of probability of transition should add up to 100%. When finished, click Apply.

5. Scroll to the top of your strategy builder and click Save. This will then generate a strategy rule with your defined classifications and transition probabilities. This strategy will call the RetailCustomerLifeTimeValue strategy to run the final mathematical calculation before determining the customer’s CLV score. For more information on the RetailCustomerLifeTimeValue strategy, see RetailCustomerValue Strategy.

6. After your strategy rule is created, you can modify it directly on the strategy rule canvas or in the strategy builder definition for the strategy. If you opt to alter the strategy directly on the strategy canvas, you will not be able to alter it afterwards from the strategy builder.

To do this, search for your strategy in the Pega Marketing portal Strategies landing page. In the same row, click Actions > Open Strategy Builder.

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Those strategies that were not created through the strategy builder initially or have been directly edited on the canvas will not have the option to Open Strategy Builder available.

RetailCustomerValue Strategy This strategy calculates CLV based on Haenlein, Kaplan (2007): "A Model to Determine Customer Lifetime Value in a Retail Banking Context". This strategy is provided as an extension point and can be modified by customers to alter the CLV calculation formula.

Where is CLV used in Pega Marketing for Financial Services? CLV is displayed on the Customer Profile in the Pega Marketing portal.

The activity SetCustomerDimensionsValue is called from the LoadCustomerMarketingProfile activity to run the CLV calculation. It also sets the customer details such as customer image, age, and Actual CLV Value and displays it in the marketing profile panel. Users can extend this activity based on their requirements.

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The calculation of the CLV value is achieved through the data flow CalculateCLVValue, which in turn calls the CLV strategy which was created in the strategy builder or manually.

Customers are expected to update step 5 of the SetCustomerDimensionsValue activity so that it references the name of the strategy they create.

If the strategy reference in step 5 is not found, the CLV will automatically be set to 0.

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Important: In Pega Marketing for Financial Services 7.31, this data flow is provided without any strategy reference. Customers are expected to save as this data flow and add the strategy they create using the CLV strategy builder.

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Sample CLV strategy In the PegaMarketingFS_CRMSample application, a sample CLV strategy is provided. This strategy is called CustomerLifeTimeValue_RetailBanking.

This is a replacement for the strategy that the customer would have created via the CLV strategy builder if it was configured with 5 classifications or 5 customer segments.

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Pega Marketing for Financial Services

Document: Customer Lifetime Value

Product Version: 7.31

Updated: November 2017