Analyzing Customer Life Time Value

Customer Life Time Value allows benchmarking of companies and helps to analyze the efficiency of companies in generating returns through their sales and marketing spend.

Net Present Value (NPV) of Life Time Value / Cost of Acquisition

• NPV of Life Time Value = [PV (Discount Rate, Absolute Life Time years, – Annual ARPU Contribution) + PV (Discount Rate, Life Time years, 0, – Annual ARPU Contribution x (Fractional Life Time years))] – Cost of Acquisition

Represents the multiple of net return in present value terms which the company generates per unit of sales and marketing spend to acquire customers

a. Annual ARPU contribution = ARPU x Contribution Margin

b. Absolute Life Time Years = Life Time in Years excluding the decimal part = INT (Life Time Years)

c. Fractional Life Time Years = Fractional part of Life Time Years

d. Example:

• Life Time Years = 3.63 years

• Absolute Life Time Years = 3 [It is not rounding off but simple exclusion of fractional / decimal part]

• Fractional Life Time Year = 0.63 [It is simply exclusion of fractional / decimal part]

e. Discount Rate should ideally be WACC; but brokers assume a flat one rate across companies companies to benchmark

Return on Investment (ROI)

• (Life Time Contribution / Cost of Acquisition)^(1/Subscribe Life in Years) – 1

Represents the percentage annual return a company generates through its sales and marketing spend to acquire customers

Alternate Long Method: Alternatively, we can use XIRR formula in excel to calculate the Internal Rate of Return, by arranging dates / cash flow in tabular format in excel
a. XIRR (Cash Flow Range, Date Range, 0)
1. Cash flow from zero period would be Cost of Acquisition
2. Cash flow from remaining period would be ARPU Contribution for each of the "Absolute Life Time Years"

• While, the last year would be showing proportional ARPU Contribution for that year based on Fractional Life Time year

3. Number of years / date range would depend on Life Time years

• Absolute Life Time years will be at an interval of a year each starting from a particular date which would be zero year till "Absolute Life Time Years"

• While, the last year would be Fractional Year based on proportional days for that year based on Fractional Life Time year

Life Time Contribution / Cost of Acquisition

• Total Life Time Contribution / Cost of Acquisition

Represents the multiple of absolute return (without the impact of discounting and without subtracting Cost of Acquisition) which the company generates per unit of sales and marketing spend to acquire customers

Life Time Value as a Valuation Methodology

Life Time Value is used mostly for benchmarking companies to check the efficiency of sales and marketing spend. But some Wall Street brokers also use the methodology to value the company.

The brokers use NPV of Life Time Value and subscribers to value the company for arriving at the Enterprise Value.

Calculation

1. NPV of Life Time Value

x

2. Subscribers or Customers

=

3. Enterprise Value

Note: Number of subscribers is chosen by brokers for a forward year based on its assumptions just like a forward year for trading comps multiple.

Once arriving at Enterprise Value, we can easily arrive at a fair value per share by adjusting for net debt and dividing the resultant with number of shares.

(The above write up includes various excel formulas, so needs to be read in that context)

This write up deals with the analyzing the Customer Life Time Value in various respects. For introduction and the calculation of Customer Life Time Value, refer to the link below:

Customer Life Time Value - Introduction

Read More

Customer Life Time Value - Introduction

Customer Lifetime Value (CLTV or LTV) can also be defined as the dollar value of a customer relationship, based on the present value of the projected future cash flows from the customer relationship. CLTV is an important concept in that it encourages firms to shift their focus from quarterly profits to long-term health of their customer relationships. CLTV is an important number because it represents an upper limit on spending to acquire new customers. The purpose of CLTV metric is to assess the financial value of each customer. This is highly useful for analyzing subscription based (SaaS) companies.

Calculation

1. Average Revenue Per User (ARPU)

x

2. Gross Margin

x

3. User Life Time

–

4. Customer Acquisition Cost (CAC)

=

5. Customer Life Time Value (CLTV)

Average Revenue Per User (ARPU)

Total revenue during the preceding 12 month period divided by the average of the number of total customers at the beginning and end of the period (BoP / EoP)

a. Total Revenue / Average Customers during the period

b. Average Customers during the period = (Customers BoP + Customers EoP) / 2

Gross Margin or Contribution Margin

Estimated as the gross margin of the total revenue or subscription revenue

a. Revenue – COGS (Cost of Goods Sold)

b. Alternatively, Subscription Revenue – Subscription COGS (Cost of Goods Sold)

User Life Time

a. Average Life Time of Customer or Subscriber; or Average Contract Term (directly given in company filings)

b. Actual Cohort based calculation
1. The company sometimes gives cohort information. Eg: 20X1 customers stays with the company in the following manner

• Stays till 20X1: 40%

• 20X2: 20%

• 20X3: 10%

• Rest stays for 20X4 and beyond

2. We can analyze in following manner:

• 40% stays till 20X1 (means for 1 year) - Assuming 20X1 customers were since beginning

• 20% stays till 20X2 - for 2 years

• 10% stays till 20X3 - for 3 years

• Remaining (30%) stays till 20X4 and beyond - assume for 4 years

3. Life Time Calculation

• 40% x 1 year + 20% x 2 years + 10% x 3 years + 30% x 4 years

• Life Time = 2.3 years

c. Retention rate / Churn rate based calculation (preferable method)
1. Life Time (in years) = 1 / Annual Churn Rate
2. Annual Churn Rate = 1 – Annual Retention Rate (and vice-versa)
3. Annual Churn Rate = Monthly Churn Rate x 12 (and vice-versa)
4. Retention Rate sometimes given as renewal rate and churn rate sometimes given as attrition / cancel / turnover rate
5. Reverse Calculation can be done from Life Time to arrive at Churn / Retention Rates

Note 1: Monthly Retention and Rate is also APPROXIMATELY equal to: Annual Retention Rate ^ 12. Conversely, Annual Retention Rate is also APPROXIMATELY equal to: Monthly Retention Rate ^ (1/12)
Note 2: Monthly Retention Rate is NOT equal to: Annual Retention Rate / 12. Conversely, Annual Retention Rate is also NOT equal to: Monthly Retention Rate x 12
Note 3: We should preferably use retention rates. But sometimes, renewal rate and retention rate are used interchangeably. This serves the same purpose but there is slight difference in the manner of their calculations, which can cause slight variations in results.

• Annual Retention Rate is the percentage of customers on the last day of the prior year who remain customers on the last day of the current year

• Renewal Rate is the percentage of customers who renew annual or multi-year subscriptions that expire during the period

Life Time Revenue

• Average Revenue Per User (ARPU) x User Life Time

Customer Acquisition Cost (CAC) / Cost of Acquisition

a. Sales and Marketing Expense for consumer segment during the relevant period divided by Gross New Members for the period

• (S&M exp.) / Gross Adds

b. Alternatively, Sales and Marketing Expense divided by sum of Net Increase in Subscribers and Churn from old Subscribers - (This method is grossing up the net subscribers addition)

• (S&M exp.) / [Net Adds + Churn x (Subs BoP)]

Customer Life Time Contribution

• Life Time Revenue x Contribution Margin

Customer Life Time Value

• Life Time Contribution – Cost of Acquisition

This introduction deals with the basic meaning and the calculation of Customer Life Time Value. For further analysis of the Customer Life Time Value, refer to the link below:
Analyzing Customer Life Time Value

Read More

Foodie Reviews

Having the possession of wandering taste buds, I like to try out different cuisines - strictly vegetarian / non alcoholic. Luckily I have partners in my crime who are always there to experiment along with me. I love to review the places I visit, food I eat and experiences I had.

In my quest to explore the flavors all around, I review the places I visit. I follow a simple methodology to review.

I use four key parameters on which I give rating on a scale of 5. A rating of 5 being the best and 0 being the worst. These include:

• Food: Taste matters and obviously its the most important ingredient of a perfect foodie review. This factors in the taste, hygiene, preparation and overall quality of the dishes. So, when I say 5, it means a real deal.
• Service: Service is also an important dimension for the review as some restaurants are innovative to not to keep you waiting - by offering complementary appetizers, while others are just so fast that they need any appetizers to keep the foodie busy. This factors in speed of delivering the order, staff friendliness, availability of multiple payment options, etc.
• Ambience: Restaurants now a days don't just offer food, they offer experiences to remember. Its an important factor to get the repeat customers. Surely an important factor for the fine-dine restaurants and would not be relevant for the take-aways.
• Value for Money: What's the use of eating out at a place if it leaves a deep hole in your pocket. Money matters - and of course, honey will taste sweeter if it comes at a right money. This factors in whether the entire experience for food, service and ambience is coming at a right price or not. Surely an important factor for the entire deal.

Overall Rating: Its simply the average of above 4 factors. Slightly up and down - of course, rounding off is part of the entire maths.

Summary: What's the use of numbers without a perfect commentary. This includes the summary of entire experience supporting all the maths above. Gives the subjective idea of the experience at a particular place.

My food journey can be checked out at my Zomato Profile

(or click the image below)

Read More

Coming Soon

Keep Calm

Interesting stuff in making...

Read More

Bitcoin: Do we welcome it or trash it?

Previous century have marked the arrival of machines while the 21^st century is being called as atomic age. But calling this age solely an atomic age will be unfair to the other disruptive areas which have grown in the past. From hardware, we have grown to software; from software we have grown to internet; from internet we are growing towards big data analytics and cloud computing. And this is just a beginning. Internet is turning out to be a parallel universe. This is just a glimpse of the gigantic opportunities which these technologies hold. Not just internet, but the science of finance has evolved over time. From being mere single accounting book keeping to double entry system; from mere sale-purchase to derivatives; from historical accounting to fair value accounting. The world is changing, so as we.

One such disruptive phenomena which has immense potential to change the way we transact is Bitcoins. Technically speaking, Bitcoin is a decentralized electronic fiat currency implemented using cryptography and peer-to-peer technology. In simple words, bitcoin is a highly secure digital virtual currency in which complex and unique mathematical numbers are considered as coins which can be exchanged freely on internet. So, there was a time of commodity currency (gold / copper coins), fiat currency (paper currency backed by law), now we look forward to maths based currency.

What’s the need?

Bitcoins are offering many advantages over the traditional currency systems. Firstly, the entire bitcoin ecosystem is decentralized. So?? This means no one country / government / person will be in a position to dominate the currency. Pure market dynamics will be directing the prospects of the currency. No individual or organization can control or manipulate the Bitcoin protocol because it is cryptographically secure. Secondly, bitcoin architecture offers the facility to send/receive funds by being anonymous. Both the parties can choose a pseudonym (dummy name) to transact with each other. A pseudonym has a private (signing) key which can be verified by a corresponding public (verification) key. So, this offers privacy of the transactions. Thirdly, the open ecosystem provides freedom to transact. Anyone can transact in any amounts. No bank holidays. No borders. No imposed limits.

Rules of the Game – Key pointers to understand the system

• All bitcoins are unique unlike the dematerialized form like in case of shares, so each coin has specific identity and this leads to transaction being settled by exchange of “change”.
• A payer specifies himself, the amount of change which he will receive back after settling the transaction.
• A transaction is broadcasted into the system through various nodes.
• Bitcoin miners are the persons who verify the transaction between two parties and consolidates various nodes of the transaction.
• Bitcoin miners get “automatic reward bitcoins” in the form of newly generated bitcoins + “transaction fees”.
• The automatic reward bitcoins halves every 200,000^th transaction block (~4 years) and will be eliminated by 2140 when all 21 million coins will be mined. After that, transaction fees will be the sole award available to the miners.
• The miners verify and create a block of various different transactions and add the block to transaction block chain.
• The transaction in turn also gets automatically added to the global ledger which keeps the record of all the transactions.
• A transaction block chain has the chain of all transaction blocks which were created since the inception of bitcoins.

How the system works?

• The system is very much open for all and the flow can be understood by a simple case below:
• Alice (payer pseudonym) has a balance of 50 BTC and wants to transfer 30 BTC to Bob (payee pseudonym).
• She will transfer 30 BTC and will specify the change of 18 BTC which she will get back from the ‘system’ net of transaction fees (assumed 2 BTC) using a bitcoin client (a software).
• The transaction is broadcasted into the peer to peer network (a kind of network topology – where there is no client-server relationship between two systems and all systems are equally capable) through various nodes.
• The transaction is verified by the miners & collated along with other transactions into a block and added to the previous longest transaction block chain available.
• The transaction also gets recorded into the global ledger.

What’s the risk?

The biggest risk which bitcoins face is acceptability – acceptability by governments, businesses and public at large. Acceptability is what makes a paper as currency. Paper currency has no intrinsic value but still it is valued because the law backs them. And since, law enforces it, people accept it. So, bitcoins acceptability will surely be deciding its fate.

Another major risk that bitcoins carry is that they are not regulated. Indeed, it’s true that regulations will limit the independence of bitcoin ecosystem. But regulations will bring some discipline in the system and will safeguard the interests of the stakeholders. A universal body should be created similar to World Bank / International Monetary Fund under international law so as to regulate the affairs of the new currency.

High levels of volatility of is also a cause of concern. The currency is traded on exchanges, Mt. Gox, being the major ones. The currency has shown immense fluctuations in the past, which makes it even more difficult to gain the trust of users. Currency volatility can be easily figured out from the chart below. Presently (as of Mar 31, 2014), the currency trades at $458.6 per bitcoin.

Although the currency allows for anonymous payments by anyone with the use of dummy names which gives privacy to the users but this gives rise to the risk of money laundering. The audit trail is created in the form of transaction block chains and recorded automatically in the global ledger of bitcoins. But the concern is how to track the money launderers as the transactions can be done with pseudonyms.

Bitcoins are also being looked as creating a bubble in the markets as they don’t have any underlying asset. But, in a way, bitcoins do have a strong concept underlying them. Whether fiat currencies have anything underlying them? No – they are just backed by law and public acceptability. So, Bitcoins also needs acceptability in order to bear the currency’s real fruits.

Safeguards of Bitcoin Ecosystem

Despite many concerns, there are inbuilt mechanisms in the bitcoin system which gives hope that the currency is here to stay. The concern of volatility will decrease over time as the system has been designed in such a way that money supply of bitcoins is restricted to 21 million bitcoins. However, all 21 million coins will take time till the year 2140 to come entirely into money supply. So, the stability of the currency will improve gradually over time.

Another safeguard of the system is that the bitcoin ecosystem provides economic incentive to act honestly. For a person with malafide intention to make money by double spending the bitcoins, he will need computing power GREATER THAN the combined computing power of all other honest bitcoin miners, which is a meagre possibility. Even if someone has such immense computing power, still it will be more profitable for that person to use the computing power to mine bitcoins instead of trying to double spend.

Bitcoin Mining – A rush for money

Bitcoin mining is being considered as a lucrative business by the software experts as they get into mining bitcoins and earn good returns. Although the transaction fees per transaction are low in the beginning years but the real punch is the automatic rewards which the miners get on successful generation of “proof of work”. “Proof of work” is basically an acknowledgement of successful transaction which gets generated after the miner successfully solves the transaction puzzle. However, the automatic rewards, which started as 50 new bitcoins for every transaction verified, will be halved every four years and will finally be eliminated. Post that, transaction fees will be the mainstay for the miners.

Current Scenario of Bitcoins – US and India

US Government viewpoints on Bitcoin

Government entity	View on Bitcoin
Securities and Exchange Commission	Considering options on Bitcoin as a security.
Commodities Future Trading Commission	Considering options on Bitcoin as a commodity, or a “marketable good produced to satisfy wants or needs.”
Internal Revenue Service	Clarified that for federal tax purposes, virtual currency is treated as property. Under currently applicable law, they cannot treated as currency.
Treasury	Companies deemed to exchange Bitcoin for traditional fiat currencies and vice versa as a business must register as money transfer businesses.
Congress	Considering the effect of Bitcoin on the Federal Reserve and weighing consumer protection options.

In India, RBI is keeping a close watch on the progress of currency and has cautioned the public against the use of Bitcoins. Income Tax department is expected to come up with their stand once RBI examines the issue completely.

The road ahead

Bitcoins are in very early stage of their adoption and many countries are reluctant to allow bitcoins. There are many concerns as well as many opportunities for bitcoins. The currency will mature over time with wider adoption. More & more issues will come into light over time and will get resolved. The important thing is that the currency has much more to offer than its shortcomings. The shortcomings can always be overcome by putting in place a regulatory system and a proper audit mechanism. We need a world unbiased towards the currencies of developed world and bitcoin provides a common platform for all. Yes! Bitcoin is here to stay.

References / Bibliography

1. Khan Academy – Bitcoin Module
2. Congressional Research Service, “Bitcoin: Q+A and Analysis of Legal Issues” (2013)
3. https://bitcoin.org
4. Joshua A. Kroll et al, “The Economics of Bitcoin Mining or, Bitcoin in the Presence of Adversaries” – Princeton University (2013)
5. www.bitcoincharts.com
6. “Major VC Declares That Bitcoin Represents The 3rd Great Era Of Currency” – Business Insider (Mar 28, 2013)

Read More