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Last three weeks of the MBA…cannot wait till I am done and ready to pursue my next adventures! However, I promised to share my recent learning on calculation of lifetime value in the database marketing class. My individual project required the calculation of my LTV to a service I have an extended relationship with. Amazon was my choice.

Relationship and Frequency Data:
- Length of active relationship = 9 months
- Average purchase over 6 months is $ 36.57
- Average frequency: 1.5 per month
- Average order: 3 books
- 99% of orders are books

Assumptions:
- Acquisition costs = $ 25
- Variable costs = 18 %
- Retention rates: 95.9% for first 6 months, 97% for the next 6 months, 98% for the next 24

There are 4 levels of customer engagement:

Level 1: Beginner (Free Super Saver)
Level 2: Purchase Patterns Captured (Buy 4, Get 1 Free)
Level 3: Heavy User, Hooked (Amazon Prime)
Level 4: Heavy User is Rewarded by Savings (Amazon Visa Card)

Each level of marketing programs reinforces continuous purchasing behavior, increases frequency and average purchase value that are paramount for increasing overall LTV.

Presently, I am a consumer on Level 3, as Amazon Prime Buyer. With the assumption of 3 years as my projected life experience with Amazon, the LTV amounts to $634. My switching costs are quite significant at this point and comprise of $79 of annual fee, ease of use, loss of automated purchase process, brand equity, security and trust that the service of the competitor might or might not be delivered.

As far as the effectiveness of this program, it did increase my frequency by eliminating time and quantity restrictions. I purchase twice as much on demand, increasing my total spending by 50 %. Simultaneously, it ensures committed 11-12 orders per year based on the annual fee that is a pre-paid shipping expense, thus increasing overall probability of purchase.

Retrospectively, I made a smooth transition from the prior 2 levels:

- Level 1 (Free Super Savor) made me buy in triplets manner which drove consistent purchase order to be roughly $28. At this stage, my LTV amounted to $348 over 3 year period.
- Level 2 (Buy 3 Get 1 Free) made me buy more books, increasing the level of frequency and ensuring that average order always amounts to $ 49. At that stage, my LTV was $ 507.
- Level 3 (Amazon Prime) increased my LTV to $ 634.
- Level 4 implies getting Amazon credit card. This could be a significant step transferring a heavy user, like me into a lifelong customer, however, the one time savings of $30 and the hassle of having another credit card is not enticing enough.

The 4 level approach works well while acquiring new users and transferring them into heavy users and ultimately into loyal customers.

Frequency of purchase, volume and average purchase value play a major role while affecting LTV, thus the following initiatives are advisable to expand into:

- Cross-selling is optimal to generate higher frequencies of purchase. Bundle packaging and offerings could be considered as alternative offerings based on the search data.
- Branding initiatives could help to seed awareness and repeat the message that online you can find it at Amazon: all the goods, ranked, recommended, traded – already pursuing community engagement
- Utilizing referral campaigns to potentially eliminate acquisition costs and carry the branding message (though the latter are quite low)
- Developing an alternative to the level 4 program (Amazon credit card), perhaps just a points card for customers that are not responsive to getting another credit card. It can still provide the same data, but alleviate the commitment factor implied in the financial decision of signing up for a credit card.
- Not sure how I missed it, but Amazon does a good job utilizing social media and web widgets to generate more interaction and customer involvement. Brian Oberkirsh has a great post on it here. I wish the design and usability of Amazon could be better and user friendly..too busy and too much going on for me when I sign up.

P.S. Just ran into a good chart on Bnet brought by iProspect on the Purchasing Power of Web Sites. Clearly, Amazon tops the score. (Added on May 15, 2007)