Sunday, September 2, 2007

Nick Carr and Customer Lifetime Value

Nicholas Carr, author of "Does IT Matter," refers to an interesting analysis regarding Customer Lifetime Value (CLV) and the Network Effect, on his blog, Rough Type. Specifically, he addresses a paper by three professors, one at Harvard Business School, regarding "free" customers. These are customers, such as buyers of real-estate or at on-line auctions, who don't pay a service provider, such as a realtor or auction house, directly. The professors are able to, for a specific unnamed real-world auction house, identify the economic value of each seller, (roughly $500), and an economic value for each buyer (roughly $550). The main -- and somewhat counterintuitive -- point of the paper is that "customers" who don't spend money can be worth more than those who do. However, a hidden impact of the analysis, which took into account numerous factors including word-of-mouth recommendation value and discount rates and Lagrangian multipliers and Jacobi-Bellman conditions and many other elements that most of us have never heard of, is that the value of each customer is essentially a constant. The implication is that, in a network of buyers and sellers, the total value generated by the network, and therefore revenue to the service provider intermediary, is linearly proportional to the size of the network. Again, this provides support for the hypothesis that network value can be linearly proportional to the size of the network.

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