Before we discuss the power of Net Predicted Revenue (NPR) as marketing’s magic number and the one number which according to me ‘solves marketing’, let’s start with the basics.
A company has customers. What it knows for sure are its past transactions with these customers.
Aggregate all these transactions in a specific period and you have the revenue for a day, month, quarter or year.
Just by looking at these numbers it is not easy to predict the future. One could extrapolate based on growth. So, if revenues have grown by 20% for each of the past three quarters, one could expect future revenues to also grow by 20%. But that does not tell the marketer who will spend how much and which customers are at risk of churning. This is where the concept of customer lifetime value (CLV) comes in. It is the present value of the future revenues from a customer. (The calculation is akin to the discounted cash flow model that companies use to calculate current valuation.)
Once we are able to calculate the CLV for each customer, we can get an aggregate view of future revenue from all customers – think of this as the Predicted Revenue. This is at a single moment in time. It is simply the area under the CLV curve, where the Y-axis has the CLV numbers, and the X-axis sorts all the customers from the highest CLV to the lowest.
So, by using CLV for each customer, we are able to calculate the forward-looking revenue for the business. What we then have to factor in is that some customers will be lost (churn) and new customers will come in (acquisition). Taking both these changes leads us to Net Predicted Revenue (NPR).
Tomorrow: The One Number To Predict Revenue (Part 6)