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Measuring customer churn rate to calculate customer lifetime value

Read advice on how to measure, define and calculate customer churn rate in this expert Q/A.

Can you provide some advice on measuring customer churn rate for an Internet company? For example, in the business of online money transfer, how would you define churn or customer drop-out?

In this case, would churn be:
* Permanent account closures, or
* Significant drop in activity (say, more than 90% in average transaction volume over a two-month period), or
* Zero activity in the last three-month period?

My plan is to attain the customer churn rate so that I can then determine the customer lifetime (N) using the relationship customer retention (CR) = 1- 1/N. (This is a calculation I found in Peppers and Roger's book, The One to One Future). Once I have found N, I can calculate the net present value (NPV) of future cash flow stream on a per customer basis.

Please let me know if this approach makes sense and how should I go about finding/defining customer churn rate and therefore calculating customer retention ratio (CR).

Because companies must be aware of both risk and significant declines in activity as precursors to customer churn rate, my suggestion would be to profile these back-end elements of the customer lifecycle as follows:

* Zero three month activity = risk
* Significant drop in activity = probable churn (midway between risk and true churn)
* Permanent account closure = true churn

For estimating purposes in calculating customer lifetime value, these might be weighted as risk = .50, probable churn = .75, and true churn = 1.00. Once these numbers are applied, it will be possible to back into customer retention ratio (CR).

This was last published in June 2006

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