Assignment 1
SyPhone is a cell phone company that sells cell phone contracts to small- to medium-sized companies, usually to equip their sales representatives and managers with cell capabilities. A typical contract covers 5 to 500 cell phones and includes phone equipment, support, service, maintenance, and unlimited phone calls for $80 to $100 per month per user.
SyPhone finds itself in a highly competitive B2B market, one in which major service providers compete alongside several large resellers. The customer base is very sensitive to price, but only if service quality is high. Typically, a substantial barrier stands against customers switching to competitors, because such a switch would involve changing equipment and retraining users. However, customer switching is a possibility when contracts are about to expire. SyPhone needs to understand the profitability of its customers before generating a renewal bid for them. For new customers, SyPhone also needs to understand their potential profitability before offering them a contract.
Historically, SyPhone has offered various discount rates to prospective customers. According to the company database, it appears that those customers who obtained the largest discounts are the least profitable in the short-term (as expected), but they have a somewhat lower churn rate. These customers tend to stay with the company longer and do not switch as much to competitors as do other customers.
These case data may be used to explore whether offering large discounts is really profitable for the company in the long term or whether it is simply shooting itself in the foot. The case also involves an analysis of the appropriate discount factors to apply to future revenue.
SyPhone customers may be grouped into two segments:
• Large accounts represent contracts that cover between 100 and 500 cell phones. A contract of 500 cell phones is pretty large for a small company like SyPhone; a large account covers about 150 cell phones on average.
• Small accounts represent contracts that cover between 5 and 100 cell phones. A small account covers about 20 cell phones on average.
When negotiating contracts, some customers receive bigger discounts than others. For simplicity, they may be grouped into two subgroups:
• No rebate customers pay $100 per month per user. This price includes phone equipment, support, service, maintenance, and unlimited calling.
• Rebate customers pay about $80 per month per user for the same service.
Table 1: Segment Description
Table 2: Transition Matrix
Segment description
The four segments (large and small accounts, with or without rebates) are listed in the first column of the segment description table. The remaining columns are as described next:
• Number of customers represents the size of each segment. SyPhone currently has 15,000 active contracts, 2,500 of them with 100 or more cell phones per contract. Note that 80% of the large accounts have benefited from substantial rebates, whereas only 60% of the smaller accounts received such discounts, which is common practice (i.e., large accounts have more negotiating power, and they use it more wisely).
• Gross margins represent revenues less costs, per year per customer. For a large account, offering a rebate of 20% diminishes gross margins by more than 40%.
• Marketing costs include any expense not related to serving the customer per se, such as visits by sales representatives, year-end gifts, thank you notes, and so forth.
• Revenues are computed as follows: #Phones × 12 (months) × Fee. For instance, a large account has 150 cells phones per contract (on average). With no rebate ($100/cell phone), such an account totals 150 × 12 × $100 = $180,000 in revenues per year.
• Costs of service are computed similarly: #Phones × 12 (months) × Costs. However, in this case, costs vary slightly per segment. Large customers that pay a higher price expect top-notch service and high-quality maintenance, which in turns increases the costs of their service. Costs of service range between $65 and $50 per cell phone per month.
Transition matrix
The transition matrix summarizes how customers evolve over time, according to the company. Typically, a customer may:
• Stay active and remain in the same segment it was in a year ago.
• Stay active but renegotiate the contract. In other words, the customer keeps the same phone provider but renegotiates the price and receives greater discounts. This evolution creates a very powerful tool for an existing customer (e.g., “Reduce the price for next year, or we will shop around”). Generally, customers who have already received large discounts are not able to renegotiate an even greater discount.
• Stop the contract and become a “lost customer.” The churn rate is defined as the proportion of customers who are lost every year. A churn rate of 30% means that the company loses 30% of its customers every year.
Note a few tendencies in the data:
• Large accounts tend to renegotiate their contracts more often than smaller accounts. Because of their economic importance, they have more negotiating power and use this power wisely to get better prices over time.
• Customers who have received discounts tend to indicate lower churn rates.
• Small accounts tend to have higher churn rates than large accounts. The more cell phones a customer has installed, the more difficult it is for that customer to change service providers; the change in equipment, voice mail, and the like could create a lot of chaos when there are 200 users in a company compared with when there are 15 users. In addition, large accounts tend to stay slightly longer with their provider than smaller accounts (which translates into a lower churn rate).
Question 1. What is the lifetime value of a typical customer in each of the four segments, in current dollar values? Assume the discount rate is 10% and profit is booked at the beginning of each period.
Question 2. Of the 15,000 customers SyPhone has today, how many will still be SyPhone customers in five years? What is the overall churn rate after five years? Answer the same questions, segment per segment.
Question 3. The sales manager of SyPhone, Nadia Morel, has the following concern: Although she is comfortable that the lifetime value you have computed takes into account the revenues and costs of a customer once that customer has been acquired, she feels strongly that you have overlooked many other factors, such as the costs of acquiring an account (e.g., sales representatives, advertising, trade shows, promotions) and the fixed costs incurred once an account is acquired (e.g., setting up and configuring the server and material, managing the transition).
Here are some figures Morel suggests:
Pre-sales costs are about $7,000 for a large prospective account and $1,500 for a small prospective account. These figures include such costs as sales representative efforts and promotions, which are incurred in the process of trying to acquire a new account, whether successful or not.
20% of the proposals to large accounts translate into signing a new customer. When a large discount is offered, this ratio goes up to 35%. For small accounts, the win rates are 15% (without rebate) and 40% (with rebate).
The fixed costs associated with winning a new customer are important. It costs about $20,000 for SyPhone to set up a large account. These are one-time, internal costs and are not billed to the client, but they will be recouped over the years. To set up a smaller account costs much less, about $3,000.
Build an Excel spreadsheet to estimate how much a prospective customer is worth, depending on whether that customer is offered a rebate. What do you learn from the updated spreadsheet? Explain the logic behind your findings and conclusions. On the basis of these results, what sales and marketing strategies would you recommend for SyPhone?
Hint: Suppose you have 100 prospective customers in each of the four segments. Compute how much it will cost to manage the pre-sale process, how many customers will be won, and the fixed costs associated with these new customers. Finally, include the lifetime values you computed previously. Divide the final figure by 100 to compute how much a prospective customer is worth.
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