This memo addresses the question of whether Nice Creams should give a free ice cream cone replacement if a customer drops it. The gross profit per family per visit is $3.8 (20%*$19). Giving away an ice cream cone that costs Nice Creams $3.15 in material costs wipes out 82.89% of the gross profit made per family. For this reason, May seems right that giving away the ice creams would adversely impact on the profitability of the business. This argument is valid especially if you assume that there are no repeat customers. However, the business operates in a suburb with most of its customers becoming repeat customers. Therefore, it is more appropriate to evaluate the profitability over the customer’s lifetime as opposed to evaluating the customer profitability on a single transaction.
The customer lifecycle value (CLV) evaluates the profitability of the customers over the entire period they remain customers to the business. The CLV evaluation is based on the following assumptions:
Children between the ages of 3-6 years will drop their cones about 20% of the time
The average family will buy from the shop for 20 years
The business will lose 5% of its customers annually
Families will visit the shop once a week and 52 times in a year
The average family spends $19 per visit.
The selling price includes a 25% mark-up which is equivalent to a 20% margin
With these assumptions the CLV is calculated as follows:
CLV= ($19*20% *52 *(20*(1-5%))) – ($3.15*52 *20% *3*2) = $3,557.84
The gross profit from the families over the 20 years is $3,754.44. The cost of replacing the ice cream cone for the three years (between ages 3 and 6) is $98.28 and so for a family with two children the cost of replacing the ice cream cones will be $196.56 over the customer’s lifetime which is 5.24% of the gross profit.
The CLV evaluation indicates that in the long run customers will become profitable and the costs associated with winning such families will constitute 5.24% of the gross profit. In the light of the CLV of $3,557.84 April seems right in giving a free replacement to children that drop their ice cream cones in order to win the goodwill and loyalty of such customers. In the long run such customers will prove to be profitable. While in the short run, it seems very costly to the business to replace the ice cream cones in the long-run it is profitable.
Nice Cream should continue offering a free replacement to families with children who drop their ice cream cones in order to win their goodwill and loyalty. Children definitely grow up and it will not be long before they learn how to hold onto their ice creams without dropping them. Since children will drop their ice cream cones about 20% of the times over a period of three years. The cost associated with creating the good will and winning their loyalty is far much less than the projected profits they will earn the business over their lifetime. Children who drop their ice cream cones and fail to get a replacement are likely to spoil the outing for the entire family and such families are not likely to be repeat customers. Furthermore, children drop the ice creams cones accidentally and they should not be penalized for it.
