Question 2 . A direct catalog retailer of fashion goods is contemplating whether or not to attract new customers using names purchased from a list broker or by randomly sending out catalogs. The cost of sending a catalog (which includes production and mailing) is $0.5. From experience, the company anticipates the response rate from a random mailing to be 1%. By analyzing the buying behavior and demographics of current customers, the retailer estimates it can rent names selectively from the broker to achieve a response rate of 4%. The list broker has set a price of $0.2 for each name.

a. What is the acquisition costs associated with each source of potential customers?

Historical data has shown that the average order size is $100 and the retention rate (percentage of customers who continue to make a purchase with the company in the next period) is 75%. Gross margins are 20% of sales and include all expenses aside from the cost of sending out catalogs. The retailer sends a catalog every month to all acquired customers. The catalog retailer is interested in knowing how many years it would take to recoup the initial costs of acquisition, assuming customers were acquired using rented names.

b. Compute the CLV for the first five years (assuming discount rate is 10%). When does a buyer becomes profitable?