Using Different Discount Rates

 

Should I use two different discount rates in the customer lifetime value calculation?

There is an argument that the majority of promotional costs are incurred before the organization receives the revenue from the customer. As an example, let’s consider a bank advertising home loans. They spend money on TV advertising in January and February, which generates new sales in March, with the majority of these loans being provided to consumers in May or June (due to the timing involved).

As you can see, the costs of acquiring a customer (or up-selling a customer) occur prior to the revenue being generated. This will typically occur in higher purchase involvement products – such as, motor vehicles, financial products, holidays and travel, major education, and so on. It usually will not occur to any significant extent for impulse low purchase involvement products – such as, candy bars, drinks, fast food, magazines, TV shows, movies, and so on.

While a highly sophisticated customer lifetime value calculation may build in the impact of this timing and apply slightly different discount rates, it is generally not appropriate for the majority of calculations. This is because it becomes another challenge to consider and then explain to management. And if certain numbers in the customer lifetime value calculation relying on assumptions, then the final CLV number will only be an estimate anyway – and the use of multiple discount rates may provide a false sense of accuracy, which really does not exist.

Further reading

For further information on the use of multiple discount rates in CLV calculations, please review this academic model that discusses several approaches formulating to customer lifetime value.