Customer Lifetime Social Value (CLSV) Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Customer Lifetime Social Value (CLSV) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Customer Lifetime Social Value (CLSV) case study is a Harvard Business School (HBR) case study written by Elie Ofek, Barak Libai, Eitan Muller. The Customer Lifetime Social Value (CLSV) (referred as “Social Clsv” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Performance measurement, Supply chain.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Customer Lifetime Social Value (CLSV) Case Study

One of the hallmarks of the digital revolution is the rise of the socially-connected consumer. Concomitantly, the ability of companies to affect and measure the social interactions among customers has grown tremendously. Consequently, in assessing the full value of each customer to the firm it is no longer sufficient to only consider a customer's worth in terms of the discounted cash flows he or she provides through direct payments, it is also critical to incorporate the indirect value generated through the customer's social influence. In this note we develop a framework for measuring and quantifying the social value that a customer generates. We derive a simple expression for Customer Social Value (CSV) and show how to combine it with the commonly used expression for Customer Lifetime Value (CLV). The combined entity is termed Customer Lifetime Social Value (CLSV). The note uses concrete examples to illustrate the main ideas and explores a host of issues related to how customers create value for the firm through their social interactions, such as the duration of social influence, reduction in acquisition costs, segmentation implications, relevance for influencer marketing programs, and connection to firm-level valuation.

Case Authors : Elie Ofek, Barak Libai, Eitan Muller

Topic : Sales & Marketing

Related Areas : Performance measurement, Supply chain

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Calculating Net Present Value (NPV) at 6% for Customer Lifetime Social Value (CLSV) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025739)	-10025739	-	-
Year 1	3469881	-6555858	3469881	0.9434	3273473
Year 2	3975750	-2580108	7445631	0.89	3538403
Year 3	3944762	1364654	11390393	0.8396	3312098
Year 4	3225484	4590138	14615877	0.7921	2554885
TOTAL			14615877		12678860

The Net Present Value at 6% discount rate is 2653121

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Profitability Index
3. Internal Rate of Return
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Social Clsv have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Social Clsv shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Customer Lifetime Social Value (CLSV)

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Sales & Marketing Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Social Clsv often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Social Clsv needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10025739)	-10025739	-	-
Year 1	3469881	-6555858	3469881	0.8696	3017288
Year 2	3975750	-2580108	7445631	0.7561	3006238
Year 3	3944762	1364654	11390393	0.6575	2593745
Year 4	3225484	4590138	14615877	0.5718	1844181
TOTAL					10461452

The Net NPV after 4 years is 435713

(10461452 - 10025739 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10025739)	-10025739	-	-
Year 1	3469881	-6555858	3469881	0.8333	2891568
Year 2	3975750	-2580108	7445631	0.6944	2760938
Year 3	3944762	1364654	11390393	0.5787	2282848
Year 4	3225484	4590138	14615877	0.4823	1555500
TOTAL					9490853

The Net NPV after 4 years is -534886

At 20% discount rate the NPV is negative (9490853 - 10025739 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Social Clsv to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Social Clsv has a NPV value higher than Zero then finance managers at Social Clsv can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Social Clsv, then the stock price of the Social Clsv should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Social Clsv should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

Understanding of risks involved in the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What will be a multi year spillover effect of various taxation regulations.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Customer Lifetime Social Value (CLSV)

References & Further Readings

Elie Ofek, Barak Libai, Eitan Muller (2018), "Customer Lifetime Social Value (CLSV) Harvard Business Review Case Study. Published by HBR Publications.