Catch-all category for posts that are not easily categorized.

Calculating the Value of Churn Reduction, Part 2: Discounting Future Cash

In the last article we introduced the Customer Lifetime Value (CLV) formula of Gupta & Lehman, and we began to explain it, starting with the expected lifetime of a customer. So was that it? The lifetime value of a customer is expected length of the customer’s subscription times the profit you make on them each month. That is:
CLV=M/c
So if the churn rate is 10%, the CLV is 10 times the recurring margin, if the churn rate is 5% the CLV is 20 times the margin, and if the churn is 1% then the CLV is 100 times the margin. This approximation to CLV is widely used, but it has some serious flaws and as we will see it can significantly overstate CLV. This article will explain why.

Discounting a Safe Cash Flow

As we all know, money promised in the future isn’t as good as cash in hand! So if you want to know the lifetime value of a customer you must “discount” future payments, or adjust them for the fact that you have to have to wait to receive the money (and for that matter may never receive it.) Both of these reasons, waiting and risk, contribute to making future money less valuable today and we will describe them in turn, below. This is an idea known to anyone who has taken a college level course in business or finance so if you already know what cash flow discounting is and why it is important you can skip this section – this article will just cover the basics.

Why is this subject important for subscriber acquisition and retention? Because if you’re thinking about spending some money to acquire or retain new customers you are going to spend that money right now or very soon. But the money you will collect from those subscribers is going to trickle in over months or years. If you think the value of present and future dollars are the same you will reach incorrect conclusions about how to get the most value for your hard earned marketing budget.

To understand how to compare present and future money, you need to use a fundamental concept of finance, which is called cash flow discounting. The simplest version of this idea is this: if you have some money you can put it in a bank account and the interest makes the money grow over time. Now turn it around and imagine receiving money after waiting some period of time: money you have to wait for is worth less than money now because you could take less money today, invest it for the waiting period, and after that you would have the full amount. The amount you have to invest now in order to have the full amount after the waiting period is called the present value of the future payment.

Let’s make a concrete example: If you are to receive say $100 at the end of the year, and interest rate is now 5%, it is the same as having around $95 today because if you had the $95 now you could put it in the bank and have $100 at the end of the year. The mathematics of how money grows with interest is described in the Appendix section below, and conversely how to calculate exactly the present value of money if you have to wait for it. This calculation depends on the interest rate that you could invest at. (If you want to know why $100 after a year with 5% interest is worth “around” $95 and not exactly $95 see the details in the appendix.)

Now an important point: what does a bank deposit and a subscriber to a service have in common? They both pay repeatedly, in installments. The periodic payments in both cases make up a “cash flow”. That is why we use the idea of cash flow discounting, borrowed from finance, to analyze the value of subscribers.

Discounting a Cash Flow with Risk

Okay, that wasn’t too hard – you have to reduce the future money to be received by “discounting it”, which depends on the interest rate. That’s the basic idea. But here’s the catch: What we just said assumes that you will get the money in the future with 100% certainty, like in an FDIC insured certificate of deposit (CD). So the interest rate we were talking about is the rate on a safe deposit. But at the time of this writing in 2014, the interest rate on savings account is practically nothing, maybe 2%. What if instead of investing your money in a safe investment, you lent it to a more speculative venture, like lending your money to your friends crowd sourced loan on Prosper.com? You’d earn a higher interest rate, of course. These days a savings account may only give you 2%, but if you invest in a venture on Prosper.com you may earn interest anywhere from 6% to 30%. That’s great if you get your money back, but if the borrower goes bust you’ll get much less, maybe nothing at all.

There is added risk, but notice that lending money to a small business venture is still similar to safe bank deposits and subscribers because you get paid periodic interest. That means that the same ideas apply, but because of the risk the interest rate should be larger. Lending at a higher interest rate, your money will grow faster if you make a risky loan, as long as you do in fact get paid. And the flip side is that money promised to you in the future by a risky investment is worth less today when you discount it than money promised by a safe investment. And here’s the point for customer lifetime value, if it’s not obvious already: cash expected from subscribers to a service should be considered like a risky investment and discounted at a high interest rate! Not the interest rate on a safe investment like a savings account.

The impact of a safe interest rate and a risky interest rate are shown in the table below. The way to read it is that $1 to be paid to you in 10 years by a safe investment (2% discount rate) is worth 82 cents today, but $1 to be paid to you in ten years by the risky investment (10% discount rate) is worth only 39 cents today – less than half as much.


Table: Discount factors at different times for low (2%) and high (10%) discount rates

What interest rate should you use to discount the future cash streams from subscribers to a service? If you don’t already have a system in place for choosing your own discount rates, we recommend discounting with the effective yield of a CCC junk bond, around 9-10% at the time of this writing. That’s probably too generous, meaning the rate for discounting subscriber payments should probably be even higher for most services. (That’s because CCC is just the worst rating for a rated company that issued a bond. Any company that can even issue a bond is way ahead of even smaller, risker ventures.) But the CCC bond rate has the advantages that the rate is readily available in published sources, it will adapt to changing times, and CCC is pretty risky.

Adapting to changing times is important: if the economy goes into recession, many things will happen, most of them bad for your subscribers and for your business. As a result, you should probably discount expected payments more heavily if there is a recession. And in a recession, the CCC bond rate will rise, because all risky ventures are likely to have a tougher time so investors will demand a higher interest to loan to junk companies. So an increased CCC bond rate will automatically increase the discounting of future subscriber cash in an appropriate way. Why would you want to value your customers less in a recession? Because in a recession you should probably be more conservative with your marketing and retention spending : reducing the calculated value of your customers is a principled and objective way to do this. (You might argue that in a recession you will need to bolster your numbers by valuing your customers more highly. That’s great if you want to make a presentation to investors – just take a more careful approach when you decide how to spend those investor’s money!)

Appendix: Mathematics of cash flow discounting


If you are mathematically inclined, the relationship can be expressed as:

where r is the annual interest rate (i.e. a percent as a decimal number like .02 for 2%) and N is the number of years. (1+r)N is the accumulated (compounded) interest rate. You can turn that equation around (by dividing both sides by the compounded interest rate) and write:

And now you can clearly see money in the future is worth less than money today because you divide the future dollars by the compounded interest you would accumulate over the time if you had the money today. (Note that (1+r)N is always greater than one whenever the interest rate is greater than zero, so future cash is always worth less than present.)

toucanBox And Sparked Improve Playtime For Kids Everywhere

Sparked & toucanBox Improve Playtime For Kids Everywhere

UK-based toucanBox is a monthly subscription box of creative and fun hands-on activities for children aged 3 to 8 years old, delivered right to their door. Each box contains everything that’s needed to keep children engaged for hours, including all the materials to complete at least 4 projects, colorful step by step instruction manuals, and a picture book, improving the quality of their playtime.

Every month, a different box is released, with themes ranging from ‘bugs’ to ‘outer space’. The boxes are tailored to suit each child’s developmental stage, and the content of the boxes differ accordingly. However, in order to be truly effective, it’s important to know what works and what doesn’t. Some boxes do better than others and in order to improve, we’ve got to identify the high performers. That’s where Sparked comes in.

Sparked is now making sure that toucanBox can deliver even more delight to kids across the UK. By integrating toucanBox’s billing data from Recurly with usage data from their website, we have identified which boxes experience greater acceptance from their customers, and which ones could use some tweaks. Sparked’s unique Retention Radar product identifies customers who are at risk of canceling and even provides the reasons for their dissatisfaction – all in time to take action and make things right.

“We’re already seeing an improvement in our understanding of what our customers really want to see in the boxes. We can figure out what themes and concepts work best and see where we can improve each month, without having to use a less efficient method like a survey” says Virginie Charles-Dear, Founder and toucan Chief.

Like many companies in the fast growing Subscription Economy, toucanBox has a huge following of customers on social media platforms. And because it’s important to get the complete view of all customer interactions and map out their journey with toucanBox, Sparked will continue to integrate new data sources, including social media presence, support and other data. With this 360-degree view of the customer, toucanBox’s staff will have a never-seen-before picture of how their customers use their product and interact with toucanBox on various platforms. Taking decisions will finally be easier and faster and toucanBox will be even more efficient at being awesome.

All of which translates to better boxes with more interesting activities being shipped to happier kids and even happier parents, improving the quality of their Quality Time. -We like that tag line so much, we might just use it!

Customer Churn Pipeline

The customer journey is fraught with key moments when a customer decides to leave. Typically, they say nothing. And the last indication that a company gets from customers before they go is one of positive sentiment. The Sparked infographic below documents when and why customers leave, but also shows key ways to keep your customers on board and happy. Sparked Killer Churn Infographic

Entrepreneur.com: 4 Steps to Knowing What Your Customers Want Better Than They Do

Sparked’s mission is to help companies deliver more value to their customers. And that starts with making sure you know your customer as well as possible. Sometimes, that means getting to know them even better than they know themselves. How is that possible? Well, in my latest article on Entrepreneur.com, I explore the methods that leading companies use to learn about their customers – methods that you can apply to your unique case as well.

4 Steps to Knowing What Your Customers Want Better Than They Do

6 Teamwork Tips To Help Implement Predictive Analytics

Sparked MD Joseph Pigato recently wrote an article for InformationWeek.com on the 6 teamwork tips that companies can use to prepare for the coming transformation, where data teams and business managers work closely together.

Sparked’s Predictive Analytics and Machine-Learning powered product, Customer Radar, goes a long way towards easing the process of getting business managers to work with data teams, by providing an easy-to-master dashboard, rich with information that can be both easily understood and quickly acted upon.

Click here to read all six tips.

[Whitepaper] Customer Retention Best Practices

The Sparked Team has always had an eye out for compelling stories and case studies, which can help subscription companies better their customer retention rates. Although there are multiple approaches and a vast combination of factors to juggle, some companies manage to stand out in their execution of customer retention programs.

Whether it’s by using a tried-and-tested communication method in a new way, or coming up with innovative solutions to customer problems, the 10 companies in our whitepaper, Customer Retention Best Practices put their customers first and that’s ultimately what led to the successes we describe in their case studies.


Download: Customer Retention Best Practices

Saving Developers 20 minutes a day with a Springloops + Pivotal Tracker Integration

Here at Sparked, we use Springloops to host our code, and Pivotal Tracker to manage our code sprints. In order to keep things organized, we have a simple commit message convention: with our commit message, we include a link to the corresponding Pivotal Tracker story. We then copy/paste the link to our commit on springloops into a comment on the corresponding story.

 

What’s great about this workflow is that it allows us to look back and cross reference our commits with their corresponding Pivotal Tracker stories and vice-versa. What’s not so great about this workflow is that it takes time to copy and paste the link to the commit into Pivotal, especially when there are many commits that cover the same story, often leading us to forget to link all of our commits to the stories that they cover. Very roughly, and especially on high-commit days, it takes us ~20 minutes per day to make sure that all of the cross linking is done correctly.

  Read more

Why Facebook Pages Are A Bust For Brands

Facebook brand pages are a bust

We all know of that Facebook dominates the web. The magnitude is staggering:
  • 70% of global internet users use Facebook
  • Facebook has over 1.26 billion users
  • 1.19 billion of their user are active each month!
  • 728 million are active every day
  • Total # of Facebook likes since launch: 1.13 trillion
But brands haven’t been able to capitalize on this popularity in the way they had originally hoped to. The promise of two-way conversations, deep engagement, and sustained relationships hasn’t materialized outside of a precious few number of brands. Even the most successful, sexiest global consumer brands can only dream of ever having 1% of their fans respond to a post on the brands’ Facebook pages. Typically, they have a .07% response rate. People have simply tuned out brands on Facebook.

I wrote an article about this disappointment for brands several weeks ago and wanted to share it here. Sparked is highly involved with helping brands engage their customers. We provide interactive, fun templates for brands to present their content and posts in ways that people actually respond to. And we use machine learning to understand users and help brands identify their best advocates. These analytics also help deliver brand posts to the users who will be most interested in the content and likely to respond to as well. Facebook simply doesn’t offer these deep analytics and optimized targeting.

We do it to help companies not only build deeper relationships and get more help from their customers, we do it to make sure that companies keep the customers they’ve worked so hard to attract. In fact, we can even use our predictive analytics tools to help companies see which customers are likely to not be customers anymore. But it starts with engagement. If you can engage customers, brands can reduce the likelihood that customers will leave them. And Facebook is the starting place because that’s where the world’s web population calls home.  

It’s not mobile first, it’s user first

SocialBrands and businesses are scrambling to develop their mobile presence.  By 2017, mobile devices will outnumber the population. What does this mean about mobile development and the user experience?

Brands are increasingly challenged to offer a tailored mobile experience that is customized, adds tangible value to the customer and offers a compelling user journey. However, brands’ goals and the user experience don’t often align.  Users want a compelling experience that provides them additional value.  Brands, on the other hand, are trying to get the most out of their users – whether that’s capturing data, growing their audience or driving sales.  The early approach to mobile centered around optimizing a desktop site for a mobile screen.  Now, with the increase in consumer expectations for an engaging experience, brands need to rethink their approach to their mobile messaging.

To accomplish this, brands need to consider three key components wen designing a user experience: social sharing, location and customization.

Here are three ways brands can guarantee a compelling user experience:

  1. Make social sharing the hub of the experience The ability to share content from your mobile device anytime, anywhere is one aspect that makes the mobile experience so compelling.   Brands must go beyond offering access to social networks and instead make social sharing an integrated part of the mobile user journey.  A successful mobile journey leverages geo-location functionality and delivers location-based content to mobile users. By integrating social sharing into the user journey, brands will offer a mobile-centric approach and grow their audience.
  2. Leveraging mobile-only experiences Another way that brands can offer an experience unique to mobile, is by offering promotions that users have to redeem on their mobile device. Starbucks is effectively leveraging mobile-only promotions to drive customers to their stores.  The brand is know for its engaging SMS campaigns, QR codes and mobile payment offerings.  Users can check their mobile balance, purchase history and receive offers that they have to redeem through their phone.  Starbucks has succeeded in delivering a mobile experience that not only delights their customers, but drives sales by
  3. Customize the user journey When designing a mobile experience, it’s important to think about how you can make the journey as easy as possible for your users. First, think about what the end goal of the [product development lifecycle].  What do you want to achieve with this app? Do you want your users to share content, upload their own content, use a promotion or drive them to a store?

The key to ensuing effective UX is by simplifying the process: keep all users actions under two minutes.  By limiting the time it takes to complete actions on mobile, this will significantly increase task completion on mobile.