As building long term customer relationships becomesparamount to the success of agricultural input marketers,a question of focus is raised: Which customers should thefirm attempt to build such relationships with? CustomerLifetime Value (CLV) is a concept some marketers haveemployed to better understand the long-term profit poten-tial of specific customers or groups of customers. CLV isthe net present value of the cash flow stream a customer isexpected to generate for a firm over time. In this study,the CLV concept was employed to better understand theprofitability of customers in the rural petroleum market.Findings suggest that customers in this market vary dra-

matically in the level of profits they generate for a firm.In addition, customer retention is important in this mar-ket with small reductions in customer retention ratesleading to large reductions in CLV. A framework andmodeling approach is also developed that marketers inother agribusiness industries may find useful as they at-tempt to measure and use customer lifetime value.Q 1997 John Wiley & Sons, Inc.

The establishment of long term relationships withcustomers is increasingly the focus of agribusinessmarketers and the central theme of many marketingconcepts such as field marketing and database mar-keting.1,2 As customers evolve over time, firmswhich have developed long term relationships withthe “right” customers (customers who will continue

Requests for reprints should be sent to Jay T. Akridge, Purdue Uni-

versity, Department of Agricultural Economics, 1145 Krannert Build-

ing, West Lafayette, Indiana 47907-1145, Phone: (317) 494-4247, FAX:

(317) 494-4333, E-Mail: akridge@agecon.purdue.edu.

Customer Lifetime Value: An Applicationin the Rural Petroleum Market

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•Brent A. GloyJay T. AkridgePaul V. Preckel

Agribusiness, Vol. 13, No. 3, 335–347 (1997)© 1997 John Wiley & Sons, Inc. CCC 0742-4477/97/030335-13

Journal Paper No. 15263 Purdue University Agricultural Research Programs. Funding for this project was provided by the Center for

Agricultural Business at Purdue University. The authors gratefully acknowledge the helpful comments of Michael Boehlje and William Schiek

on an earlier version of this article. In addition, the assistance of several individuals from the case firms participating in this research was

fundamental to the success of the project. An earlier version of this article was presented at the Sixth World Congress of the International Food

and Agribusiness Management Association, Cancun, Mexico, May 28–30, 1996.

• Brent A. Gloy is a Ph.D. student in agribusiness management and a USDA National Needs Fellow in Agribusinessat Purdue University. • Jay T. Akridge is an Associate Professor in the Department of Agricultural Economics and Associate Director of theCenter for Agricultural Business at Purdue. • Paul V. Preckel is a Professor in the Purdue Department of Agricultural Economics.

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to be in the market) will have a definite advantageover competition. Development of customer rela-tionships can be costly, so firms must consider cus-tomer profitability as they enter into these relation-ships. The firm must first determine that therelationship is or has the potential to be profitablebefore it invests the resources required to developthe relationship.

When evaluating customer profitability, marketersare often reminded of the 80/20 rule (80% of theprofits are produced by 20% of the customers). 3

There are several reasons that the absolute and/orrelative level of profits that customers generate foran agribusiness might differ. All customers may notpay the same price for the same product. Or somecustomers may receive more service or more prod-uct for the same price. For example, a firm may of-fer a volume discount to customers that qualify, ora specific customer may take advantage of specialpromotional deals more regularly than other cus-tomers.4 The level of customer profitability mayalso differ because some customers cost more toserve than other customers. It might cost more tofill a customer’s order if that customer requires fastdelivery or more service than a typical customer.

One method that can be used to characterize theseprofit differences is the customer lifetime value(CLV) model. Customer lifetime value is the net pre-sent value of the cash flows a customer is expected togenerate for a firm over the length of the customer’srelationship with the firm.5 Jackson5 indicates thatcustomer lifetime value tells a firm how much eachcustomer contributes to overhead and profit. Basi-cally, the revenues and expenses for a specific cus-tomer are projected over the appropriate planninghorizon and then discounted back to current dollarsto calculate the customer’s lifetime value.

Customer lifetime values have a number of poten-tial applications when making marketing decisions.For instance, the lifetime values could help a firmdetermine how much it can afford to spend to ac-quire customers. Campbell6 shows how the lifetimevalue model helped non-profit organizations, manyof whom focus their efforts on lowering the cost ofacquiring a contributor, to improve their fund rais-ing efforts by focusing on long-term costs and re-turns. As Campbell asserts, sometimes the best cus-

tomers might cost more to obtain, but will generatedrastically higher returns than the customers thatare less costly to obtain. The CLV model can assistthe firm in quantifying this tradeoff. Customer life-time value can help the firm examine the impor-tance of customer retention. In many situations, theprofit is not in the customer’s initial purchase, butin repeat purchases made at later points in time.7

The CLV model can also help firms examine theconsequences of a change in a customer’s buyingbehavior on the long-term profitability of the ac-count. Other possible marketing decision makingapplications include evaluating the profit potentialof prospective customers, prioritizing investmentsin communication programs, and makingproduct/service mix choices.

The objectives of this article are to explore the useof the customer lifetime value model in making deci-sions in the rural petroleum market. First, the dataand methods necessary to develop and use the CLVmodel will be discussed. Single period profitabilityestimates for several customer segments will be de-veloped. Then, the single period results will be usedto make projections of future revenues and costs sothat a CLV can be calculated. Next, the CLV modelwill be used to compare the value of customers cur-rently in the customer base and prospective cus-tomers. Finally, the CLV’s will be used to evaluatealternative marketing strategies and analyze theprofitability of two of the firm’s customer segments.These strategies and analyses will demonstrateCLV’s use when addressing marketing issues such asdeveloping communication strategies, target marketselection, customer acquisition, and customer re-tention. Each of these uses of CLV will be discussedin some detail and specific examples provided.

Data and Methods

The data used in this analysis were obtained from afirm in the rural retail petroleum industry. Thisfirm sells two main product lines, liquefied petrole-um (LP) gas and liquid petroleum fuels such asdiesel and gasoline. Products in both lines are de-livered to the customer. These products are sold tomany different market segments, including farms,

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homes, commercial businesses, and government en-tities. There is potential for large profitability dif-ferences across customers in this market as pricesreceived, costs of service, and products purchasedin each segment are quite different. There are fourbasic steps required to calculate CLV’s in this mar-ket:

1. Define and identify the customer segments;2. Assess the current profitability of the segments;3. Make projections of future segment profitability;

and4. Combine this information with a planning horizon

and the firm’s discount rate to estimate the cus-tomer lifetime values.

The lifetime value model requires revenue and ex-pense information over the life of the customer’sexpected relationship with the firm. Revenue andexpenses for any individual customer are impactedby several factors. The revenue that a customergenerates for the firm is influenced by the volume ofpurchases the customer makes and how these pur-chases change over time. Cost of service may be im-pacted by volume of purchases, types of servicesrequired, and distance traveled when making deliv-eries. By visiting with managers, observing the salesprocess, and examining financial records such asincome statements and sales reports, a set of factors

which determine profit at the customer level wasdefined. These factors included volume of pur-chase, type of product purchased, service require-ments, gross margin on sales, price sensitivity, fre-quency of purchases, equipment required, andseasonality of purchases. Using these factors, thecustomer base for the rural retail petroleum firmwas divided into 11 segments. Each of the 3,281customers in the firm’s customer base was then as-signed to one of the 11 specific customer segments.The segments and the number of customers in eachsegment for the case firm are shown in Figure 1.

With customer segments defined, the profitabilityof individual customer segments was then deter-mined. The firm’s income statement provided themajority of the financial data that was used in thisprocess. The income statement for the total firm isessentially separated into several mini-income state-ments, one for each customer segment. This was ac-complished with a step-wise revenue and cost allo-cation process, where managers systematicallyallocated income and expenses to the customer seg-ments. Once these customer segment revenues andexpenses were determined, the segment totals weredivided by the number of customers in the segmentto determine the profitability of an average cus-tomer in each of the segments.

While fully allocated profit figures were calculat-ed, the focus of this article is on contribution mar-

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Figure 1. Customer segments and the number of customers in each segment.

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gin.a The contribution margin was calculated bysubtracting cost of goods sold and directly assigna-ble customer expenses from sales. The primary di-rectly assignable expenses were employee expenses,repairs and maintenance, supplies, and truck ex-penses. Assignable expenses accounted for 52% oftotal operating expenses. The major expense itemsthat were not assigned directly were fixed facilityexpense (18% of total operating expenses), allocat-ed indirect expense (11% of total operating expens-es), allocated employee expenses (6% of total oper-ating expenses), interest expense (4% of totaloperating expenses), insurance expense (3% of totaloperating expenses), and property taxes (2% of to-tal operating expenses).

Segment Contribution Margin

The level of contribution margin (annual figure) be-ing generated by the individual segments varieddramatically (Table I). The low profit segments, LPagricultural production and LP commercial, were

not generating enough revenue to cover the assigna-ble costs of doing business, while the high profit seg-ments, LP home heat and liquid fuel home heat,were contributing 29% and 28% of sales towardnon-assignable costs respectively. The average an-nual sales and contribution margin figures for theeleven customer segments are shown in Table I.Some segments, such as the transport segment, gen-erate a great deal of sales per customer, but a lowcontribution margin per customer. Other segments,liquid fuel home heat, for example, exhibit relation-ships that are virtually the opposite (Table I).

While the analysis identified 11 customer seg-ments, this article will focus primarily on the find-ings for two of these segments, LP home heat andlarge farm liquid fuel. These segments were criticalto the case firm’s long term business plan. In addi-tion, the segments represent two very differenttypes of customers with respect to volume of pur-chases, gross margin, and cost of service. These dif-ferences will allow evaluation of the CLV modelover a wide range of customer characteristics.

Customer Lifetime Value

The contribution margin figure discussed above is aone year estimate of customer profitability. There

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aThe contribution margin was used because it was considered to be a

more reliable measure of segment profitability. However, the full cost

allocation results did not differ significantly from the assignable ex-

pense allocation results.

Table 1. Average Annual Sales and Contribution Margin by Customer Segment.

TotalTotal Segment Contribution

Customer Segment Contribution Number of Sales per Margin perSegment Sales Margin Customers Customer Customer

LP Home Heat $945,229 $273,485 1,837 $515 $149LP Ag Production $231,363 ($3,112) 86 $2,690 ($36)LP Commercial $99,156 ($1,334) 26 $3,814 ($51)Large Commercial $918,626 $62,877 32 $28,708 $1,965Bid $454,029 $20,940 22 $20,638 $952Large Farm $521,217 $39,817 48 $10,859 $830Small Commercial $196,562 $27,882 47 $4,182 $593Small Farm $809,357 $117,137 240 $3,372 $488Transport $767,548 $8,616 29 $26,467 $297Home Heat $453,229 $127,769 914 $496 $140Total Firm $5,396,315 $674,077 3,281 $1,645 $205

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are several characteristics of customer relationshipsin the rural petroleum market that make it moreappropriate to look at profitability over a longertime horizon. First, the costs of obtaining customersin this market are high. Often, the one period re-turns will not off-set the initial customer acquisitioncosts. In addition, customer retention, defined asthe one-period probability of retaining a customer,is very high in many rural petroleum markets—ashigh as 99% in some. Once a firm establishes a cus-tomer relationship, there is a very high probabilitythey will maintain that relationship over time.

The investment in a customer can be evaluatedmuch like the purchase of a traditional business as-set. The cash flows required to obtain a customer canbe considered as the initial cash outflows, and theprofits generated through time can be treated as thecash inflows in an investment analysis. The revenuesand expenses are then discounted at the firm’s cost ofcapital. It is the present value of these cash flows thatis defined here as the customer’s lifetime value.

As future cash flows from the customer relation-ship are estimated, it is important to note that therevenue generated from an individual customer isnot known with certainty. There are uncertaintiesrelated to both acquiring and retaining a customer.To capture these uncertainties the lifetime valuemodel should incorporate the probability of acquir-ing a prospective customer and the probability of re-taining a current customer. The probability of ac-quiring a customer is partially a function of thefirm’s investment in acquisition activities. The prob-

ability of retaining the customer is, among otherthings, a function of investments in loyalty programsand other retention activities. In this study, theseprobabilities were obtained from estimates made byfirm managers. The specific model used to calculatecustomer lifetime value is presented in Appendix 1.

Lifetime Values for Petroleum Customers

For this analysis, the cash flows are assumed to bereal and discrete. The base assumptions for theCLV calculations for the two example segments—LPhome heat and large farm liquid fuel—are shown inTable II. The lifetime value for each of these cus-tomers is the net present value of their contributiontoward non-assignable costs over the planning hori-zon. Each of the variable values in Table II was tak-en from the one-period customer profitabilityanalysis. The lifetime value that is generated usingthese assumptions is a lifetime contribution marginbecause only directly assignable operating costswere considered—i.e., the non-assignable cost com-ponents are not incorporated into this analysis.Note that the scale of the two accounts is quite dif-ferent. The lifetime value of a current large farmcustomer (a customer the firm is already doingbusiness with, where the initial equipment invest-ment and sales costs are considered sunk costs) is$4,966, while a current LP home heat customer’slifetime value is $968.

Lifetime values for all 10 segments are shown in

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Table 2. Base Assumptions for the Customer Lifetime Value Model.

Variable Large Farm LP Home Heat

Annual Sales $10,859 $515Cost of Goods Sold $9,015 $270Operating Costs $1,014 $95Lifetime 10 years 10 yearsProbability of Retention .97 .99Probability of Acquisition 1 1Equipment Investment $1,968 $796Real Discount Rate 8% 8%Customer Lifetime Value Without Initial Equipment Investment $4,966 $968

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Figure 2. (The assumptions used to calculate theseCLV’s are presented in Gloy.8) The CLV’s rangefrom a high of $11,762 for a large commercial liquidfuel account, to (2$305) for a LP commercial ac-count. Clearly, there is a wide disparity in the prof-itability of the various segments the firm serves. Ingeneral, this firm was earning a greater rate of re-turn in the liquid fuel market, relative to the LPmarket. (For this firm, the LP business was rela-tively new, and their aggressive introductory pric-ing policies helped keep profitability low.) With in-dividual CLV’s calculated, how can an agribusinessfirm put this kind of information to work?

Applications of Customer Lifetime Value

In this section, the use of customer lifetime value inmaking marketing decisions will be explored. TheLP home heat and large farm liquid fuel segmentswill be used as examples. The decisions consideredinclude: communication strategy development, de-termination of maximum promotional outlays,analysis of new customer investments, evaluation ofspecial offers, and analysis of changes in customerpurchasing behavior.

Marketing Strategies Based on Lifetime Value

The difference in lifetime values shown in Table IIsuggests different marketing strategies for the twosegments. A more personalized, targeted approachwould be more likely for the large farm account,while a less expensive (on a per customer basis) ap-proach would make more sense for the LP homeheat segment. The larger the lifetime value, themore that a firm can spend to acquire or keep anindividual account. A personalized approach ismore appropriate for the large farm account be-cause it has a much larger lifetime value and thus,more investment can be made to retain the largefarm. The smaller lifetime value of the LP homeheat account means that the firm must operate witha lower per customer marketing budget. Approach-es such as newspaper and radio advertising tend tocost less on a per customer basis.

Evaluating Promotional Outlays

In order to evaluate a specific promotional pro-gram, the firm could compare the investment in theprogram with the number of customers the cam-

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Figure 2. Customer lifetime value by segment.

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paign is expected to attract. Marketing outlays areoften judged in terms of immediate pay-back—howmuch immediate response is required to cover thecost of the promotion. Under the suggested ap-proach, the marketing outlays would be comparedwith the lifetime values of the customers attracted.For example, if the firm spent $40,000 on a LPhome heat customer acquisition campaign, it wouldneed to attract at least 42 LP home heat customersfor the campaign to be a success (campaign outlay($40,000) divided by the average lifetime value percustomer [$968]). If judged by immediate (oneyear) profit, the hurdle rate would be 269 cus-tomers (campaign outlay ($40,000) divided by ini-tial period profitability [$149]). Obviously, the de-cision on whether or not to pursue the campaignwould depend on which criteria was used. The CLVapproach is the more appropriate because it recog-nizes all of the cash flows and not just those associ-ated with one-period sales. While attracting 269customers would clearly be a better response, anyresponse of at least 42 customers would representprofitable returns to the proposed marketing pro-gram.

Evaluating New Customer Investments

It is also possible to evaluate investments in the hu-man resources and physical assets required to ob-tain new customers. For example, using the CLV,the case firm knows that the maximum equipmentinvestment it can make for a typical large farm ac-count is the lifetime value of a large farm accountalready in its customer base, $4,966. Any invest-ment over $4,966 which was made to acquire the ac-count would generate a negative lifetime value.

Based on data provided by firm managers, the firmtypically makes a $1,968 investment in storageequipment that will be placed on the customer’s farmwhen acquiring a large farm account. The lifetimevalue of an existing large farm account was $4,966.Since equipment costs must be subtracted from thecurrent lifetime value, the equipment investment re-duces the lifetime value of the large farm to $2,998.The firm could now examine how many years theyneed to keep the customer in order to generate a pos-itive net present value. For the large farm account,

three years of business from the customer are neces-sary before the lifetime value is positive.b

The firm could also evaluate sales costs and theprobability of acquisition. First, assume that ac-quiring a large farm account would take 25 hours ofa salesperson’s time (sales call preparation, drivingtime, and actual sales calls) and that this time costs$18 per hour. The total initial sales cost is $450.The sales costs would be deducted from the lifetimevalue of the large farm account along with the ini-tial equipment investment. The minimum probabili-ty of acquisition that would generate a positive life-time value could then be calculated. The minimumprobability of acquiring the customer in this exam-ple is 15%. If the firm believed that the probabilityof acquiring the customer was higher than 15%,these types of large farm accounts could be prof-itably targeted. If the firm is unsure of the proba-bility of acquisition, it could monitor its successrate over time to determine if the account shouldcontinue to be prospected.

Special Offers

If the firm learns that a large farm account is con-sidering a new supplier, it could develop specialprograms, such as making price concessions or of-fering special services, in an attempt to retain thelarge farm account. If the firm immediately offeredthe large farm customer a 5% price reduction, itwould find that the lifetime value of the customerwas reduced to $2,126. (In addition to the reduc-tion in CLV for this specific customer, the impact ofsuch increased services and/or price concessions onsimilar customers would need to be considered.) ALP home heat account, on the other hand, is lessvaluable and the firm must consider carefully anyspecial concessions for an individual account. If alarge number of home heat accounts were consider-

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bThe example ignores the salvage value of the equipment. This

would tend to bias the estimate of customer lifetime value downward.

However, the example also ignores the costs of moving and relocating

the equipment. These costs could be significant and this omission would

tend to bias the estimate of CLV value upward. The likely overall effect

is that the customer lifetime value is slightly underestimated by these

omissions.

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ing leaving then such concessions would be morejustifiable.

Examining Changes in CustomerPurchasing Behavior

The lifetime value could also be used to examine theimpact of changes in the purchasing behavior of theaccounts. Many farms are switching to no-till farm-ing methods which reduce fuel use by about 40%.The firm could evaluate the impact of the switch tono-till on the lifetime value of the average largefarm account. Table III shows the lifetime values ofa current large farm customer that switches to no-till at the beginning of different years of the plan-ning horizon. The number adjacent to the year ofthe switch indicates the realized lifetime value of alarge farm that switches to no-till in that year. Forexample, a large farm that switches to no-till fouryears from today would generate a realized lifetimevalue of $3,811 (Table III).

In this case, fuel use is projected to decline by40% immediately in the year of the switch and re-main at this lower level throughout the planninghorizon. Under this scenario, lifetime value is virtu-ally unchanged if the customer switches to no-till

late in the planning horizon. The adoption rate ofno-till would be important to monitor for both ex-isting customers and prospects. If the firm predict-ed that large farms would switch to no-till in thenext two years, it would want to compare the newlifetime value of the large farm ($3,287) against oth-er types of customers when making marketing deci-sions.

Customer Lifetime ValueUnder Acquisition Uncertainty

The previous examples dealt with situations inwhich the firm was certain of obtaining a customer.There is a great deal of uncertainty associated withacquiring new customers, and this uncertainty re-duces the expected CLV. For example, suppose acustomer has a lifetime value of $10,000 when theprobability of acquisition is 1.0, but the truechances of acquiring this customer over the next tenyears are extremely low, 5%. Even when the proba-bility of retention is held constant at 1.0, the ex-pected lifetime value of this customer is only $2,129given the very low likelihood of actually obtainingthe account.

The large farm customers in the case firm’s mar-

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Table 3. The Effect of No-Till Adoption on a Current Large Farm Customer’s Lifetime Value.

Current Customer Reduction in RealizedYear of Switch Realized Lifetime Value Lifetime Value (%)

1 $2,980 40%2 $3,287 34%3 $3,563 28%4 $3,811 23%5 $4,033 19%6 $4,233 15%7 $4,413 11%8 $4,574 8%9 $4,719 5%

10 $4,849 2%

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ket tend to be very loyal and the market is notgrowing, which makes customer acquisition diffi-cult. The LP home heat customers are also loyal,but this market is growing as the urban portion ofthe market expands. As the case firm continues toexpand its business, it needs to identify whichprospects offer the highest expected lifetime val-ues. For this reason, the probability of acquisitionwill be considered. Firm managers were asked toestimate the probability of obtaining new cus-tomers in the large farm and LP home heat seg-ments. In both cases they estimate the probabilityat .2—i.e., two out of 10 customers approached inthese segments are actually acquired by the com-pany each year.

The firm also estimated that it would take a saleseffort of about 25 hours to approach a large farmcustomer. Only one hour of selling time was re-quired to approach a LP home heat customer. Thecost of the sales time was estimated to be $18 perhour which would include salary, commissions,benefits, etc. The firm will also be required to placesome equipment (Table II) on the new customers’property. The CLV model used assumes that therewere no carryover effects of sales effort and thatthe customer would be called on each year until ob-tained or up to a maximum 10 years. Once the cus-tomer was obtained the probability of customer re-tention was 97% for the large farm account and99% for the LP home heat account.

Under these assumptions, the CLV for the prospec-tive large farm account was $275. The CLV for theLP home heat account was 2$55. This exampleshows that the firm can expect to make a profit byprospecting the large farm customers given the as-sumed acquisition and retention probabilities. In or-der to make a profit in the LP home heat segmentthe firm would need to increase the probability ofacquisition to .31. A break-even point can also becalculated to evaluate the effects of increased salesefforts focusing on this segment. If the firm decidedto allocate 2 hours of selling time to a new LP homeheat account they could determine that the mini-mum acceptable response rate would be 40%. Thefirm must improve its acquisition rate to serve theLP home heat segment profitably if additional timeis invested. It must also closely monitor the proba-

bility of acquisition in the large farm segment as thebreak-even acquisition probability is 15%.

The difference in the lifetime value of the currentand prospective customers gives the firm an indica-tion of what it could spend to retain its current cus-tomers. The CLV of the current and prospectivelarge farm accounts differed by $4,691 ($4,9662$275), while a similar figure for the LP home heataccount was $1,022 ($968 2 (2$54)). This differ-ence serves to reinforce the importance of retainingcurrent customers. Many firms have examined ac-quisition response rates. However, firms shouldalso concentrate on monitoring and improving cus-tomer retention rates.

Evaluating Customer Retention

An important issue facing agribusiness marketers iscustomer retention. By comparing the expected life-time values under alternative customer retentionrates, one can directly estimate the amount thatcould be profitably spent to increase customer reten-tion. In order to gauge the value of increased cus-tomer retention, all variable parameters, except cus-tomer retention, were held constant—i.e., there is nointeraction between high rates of retention and highlevels of sales. (With the data available for this studyit would be impossible to estimate this relationship.)The analysis was conducted assuming that the cus-tomer is in the customer base—i.e., there is no un-certainty with regard to customer acquisition. This isrealistic because firms considering investments incustomer retention activities would be concentratingon customers already in the customer base or cus-tomers known to be coming into the customer base.The equipment costs and initial sales costs were con-sidered, as the firm had to make these investments toacquire the customers. In this way the CLV becomesa realized lifetime value. The retention rate was var-ied from 0.70 to 1 by increments of 0.05. Figure 3shows the customer lifetime value of a large farm ac-count under alternative retention rates.

Firms would not want to serve the large farm seg-ment if the expected retention rate is below 75%(Figure 3). The actual break-even point is approxi-mately 74%. The amount that a firm would gain by

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improving the retention rate is also shown in Figure3. An increase in retention from 80% to 90% wouldincrease the expected lifetime value of a large farmaccount by $1,049.

This curve provides the firm with a specific way tovalue its retention spending. If retention can be in-creased from 80% to 90% for a present value lessthan $1,049 per account, the firm would increasethe net lifetime value of its customers. The analysisassumes that the customer would move to a higherretention rate for the next ten years. The effect ofinvestments in customer retention activities overtime would be much more difficult to estimate fromthis curve.

Figure 4 shows the incremental benefits of reten-tion and gives management an effective way to com-pare the marginal benefits to the marginal costs ofretention. In most cases, management has a reason-able estimate of the marginal costs of increasingcustomer retention. However, they do not have ameaningful way to measure the marginal benefits ofcustomer retention because they typically do notcapture these benefits over time. The relationshipshown in this curve could help agribusiness mar-

keters understand the marginal net present value ofincreasing customer retention. The firm can nowmake a more informed decision about the value ofincreasing customer retention.

This method is superior to other methods thatvalue retention in one period. Many measures sim-ply calculate the increased sales in one period andcompare that marginal revenue to the costs of in-creasing customer retention. This could result in alower than optimal amount of spending to increasecustomer retention. Measures that only account forone period benefits clearly tend to undervalue re-tention efforts. It is also important to point outthat the cost of increasing customer retention likelybecomes an increasing cost at some point. As cus-tomer retention is increased, the costs of moving toeven higher levels might well increase at a fasterrate and outweigh the benefits of the increased re-tention.

The incremental benefit of increasing retentioncan be acquired in many ways. Firms can invest inimproved services or loyalty programs that rewardcustomers for remaining with the firm. The firmcan also retain customers by reducing price (cutting

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Figure 3. Customer lifetime value for large farm accounts under alternative retentionrates.

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Figure 4. Incremental value of increasing customer retention—large farm accounts.

Figure 5. Minimum gross margin on sales for different retention rates—large farm accounts.

gross margin). The firm might believe that if theyreduce gross margin by a certain amount they willbe more likely to keep the customer.

The firm can use the CLV information to deter-mine the minimum gross margin that is necessary to

make CLV equal to zero. By setting the customerlifetime value equal to $0, using a retention rate of.85, and solving for gross margin, one can find theminimum gross margin that a large farm customerwith a retention rate of .85 must generate. In this

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case, the result is that gross margin can be set aslow as 14.98%. Figure 5 shows the minimum grossmargin on sales a firm could set for different cus-tomer retention rates. The lowest gross margin thatthe firm can operate with and still generate a posi-tive lifetime contribution to non-assignable costs is12.66%. At this gross margin, the customer reten-tion rate must equal 100%.

Summary

This research developed a basic framework forcalculating customer lifetime value and applied itto several marketing decisions that agribusinessfirms face. However, some extensions of this modelwould be useful. The relationships between theprobabilities of retention and other variables werediscussed, but not considered in the analysis. Amethod to estimate the effects of customer reten-tion on sales, costs, and gross margins throughtime would be of interest. This study also consid-ered no interaction between customer satisfactionand the variables driving lifetime value. Firmswith customer satisfaction data could find it possi-ble to calculate the effects of increased customersatisfaction on lifetime value. The study used cus-tomer segment averages, not actual customer ex-penses and revenues to calculate lifetime values.The framework could also be applied to specific

customers instead of average customers. Thiscould allow an even more segmented marketing ap-proach. The lifetime value could be expanded toaccount for the value of customer referrals orsales effects based on acquiring market leaders.For example, many firms often do business withcertain customers for strategic purposes becauseother customers might be more likely to do busi-ness with the firm if an opinion leader in the areais doing business with the firm.

The lifetime value model works well in estimatingminimum acquisition and retention levels. Evaluat-ing long-term investments such as customer reten-tion without accounting for the long-term cash flowsthat they generate can lead to ineffective marketingdecisions. The model would be extremely valuableto firms that are using pricing policies to retain cus-tomers. The CLV framework is also useful for firmsmaking strategic marketing decisions because it re-quires that the firm consider the long-term behav-ior of their customers. The lifetime value modelprovides firms a way to measure the benefits of in-creased customer retention, which is one thing thatfirms who are attempting to increase customer satis-faction are trying to accomplish.

At a time when agribusiness’s marketers are fo-cusing on long-term customer relationships, cus-tomer lifetime value offers a useful tool for estab-lishing the value of these relationships andfine-tuning marketing strategies consistent withthis goal.

Gloy, Akr idge , and Precke l

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References

1. W. D. Downey, “Fragmented Ag Markets Create a Need fora Field Marketer.” Feedstuffs 66, 35, 1 (August 22, 1994).

2. L. D. Whipker, J.T. Akridge, and P. Wang, Applications ofDatabase Marketing in U.S. Agribusiness Firms: An Ex-ploratory Study, Staff Paper No. 96-4, Center for Agricul-tural Business, Purdue University, West Lafayette, Indi-ana, March 1996.

3. R.S. Duboff, “Marketing to Maximize Profitability,” TheJournal of Business Strategy, 13, November-December 10(1992).

4. B. Shapiro, V. Kasturi Rangan, R. Moriarty, and E.B.Ross, “Manage Customers for Profits (Not Just Sales),”

Harvard Business Review, 65, September/October, 101(1987).

5. D. Jackson, “In Quest of the Grail: Breaking the Barriersto Customer Valuation,” Direct Marketing, March, 44(1992).

6. B. Campbell, “Lifetime Donor Value: A Powerful AnalysisTechnique,” Fund Raising Management, July, 16 (1994).

7. A. Hughes and P. Wang, “Media Selection for DatabaseMarketers,” Journal of Direct Marketing, 9, 1, 79 (1995).

8. B.A Gloy, “Customer Lifetime Value: An Application in theAgricultural Input Industry,” Unpublished M.S. Thesis,Purdue University, May 1996.

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Appendix 1. Customer Lifetime Value Model

The model used to determine the lifetime value of a cus-tomer was

where CLV is the expected lifetime value of a customer; ais the probability of acquiring the customer; ACQinvi isinvestment that is made when the customer is acquired inyear i; VCacquirei is the variable cost of acquiring thecustomer in year i; Qi is the quantity of units purchasedby the customer in year i; FCacquirei is the fixed cost ofacquiring the customer in year i; wagei is the hourlywage for a salesperson calling on the customer in year i;timei is the number of hours that the salesperson spendsattempting to acquire the customer in year i; r is the cus-tomer retention rate; Pi is the unit price charged to thecustomer in year i; CGSi is the per unit cost of goods soldto the customer in year i; VCi is the variable cost per unitsold to the customer in year i; FCi is the fixed cost associ-

ated with the customer in year i; VCloyali is the variablecost of loyalty programs for the customer in year i;FCloyali is the fixed costs of loyalty programs for thecustomer in year i; d is the discount rate for the firm;and n is the lifetime of the customer relationship inyears. The term outside the square brackets, (1 2 a)i21

a, yields the probability of acquisition in year i, andthe term inside the brackets gives the expected lifetimevalue of a customer acquired in year i, less the cost ofacquisition.

When the probability of acquisition is equal to one, themodel reduces to the simplified form shown below. Bothof these models consider retention of the customer in thefirst period as certain and allow for the chance that acustomer can be lost after the initial period.

2ACQinvi2

VCacquirei * Qi2

FCacquirei

(1 1 d )i21 (1 1 d )i21 (1 1 d )i21

iwagei * timei

2Oj50 (1 1 d ) j

n2ir j((Pj1i 2 CGSj1i)*Qj1i2(VCj1i*Qj1i)2FCj1i)

1Oj50 (1 1 d ) j1i

n2ir j(VCloyal j1i* Qj1i 1 FCloyalj1i)

2Oj50 (1 1 d ) j1i

n

CLV 5O (1 2 a) i21 ai51

2ACQinvi VCacquirei*Qi FCacquireiCLV 5 2 2

(1 1 d)i21 (1 1 d )i21 (1 1 d)i21

wagei*timei2

(1 1 d) j

n

1O ri21[(Pi 2 CGSi)*Qi 2(VCi*Qi) 2FCi]

i51 (1 1 d)i

n

2O ri21[(VCloyali*Qi) 1 FCloyali]

i51 (1 1 d)i

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