In this table, 100,000 customers are acquired originally. We are following their purchase history for the next three years. The first thing you will notice is that 40% of them disappear after the first year. The retention rate is only 60%. In future years the retention rate grows. The loyalty of retained customers is higher than that of newly acquired customers. As customers stay with you, their number of orders per year and their average order size tends to increase.
We are assuming a 70% cost of sales. Your number may be different. The cost typically goes down after the first year. The cost of customer service to existing customers is usually lower than that to new customers. It costs you $55 to acquire a new customer. This is computed by taking all your advertising and sales costs and dividing this by the 100,000 customers that you acquired. We are assuming that you spend $20 per customer per year on subsequent marketing, including the cost of the database that provides the information needed for this table, and is used to provide the personal communications needed to improve the retention rate.
The Gross Profit is simply the revenue minus costs. We have to divide this by a discount rate to get the Net Present Value of the expected profits. The discount rate (based on interest rates) is needed because future profits are not worth as much in today's money as present profits. The formula for the discount rate is