Question

Yeshiva Financials (“YF”) is a small boutique firm that offers various financial services to qualified investors. On average, each customer generates $25,000 of sales per year for YF, which earns a margin of 25%. Its current retention rate is 75% per year, which is similar to other competitors in the market. Sales per customer are expected to be flat for the foreseeable future. Assume a 10% discount rate and an infinite consumption horizon.

1. The chief marketing officer is considering a one-time expenditure of $600,000 to increase the share of Yeshiva Financials through advertising, sales calls, and sponsorships.

At least how many new clients does YF need to acquire to make this investment pay off in the long term? That is, at what point (or # of clients) does this $600,000 marketing expense make sense?

2. Alternatively, YF can try to improve its value by improving its retention rate. Now, assuming YF currently has 500 customers, what is the maximum amount of money that YF should be willing to spend to permanently increase its retention rate by 1% (that is, from 75% to 76%)?

What are some specific marketing strategies that YF could do to increase its retention rates?

Please identify at least two strategies.

Answer 1

Margin per client = 25% of 25,000 = 6250

1. Let the number of clients be x.

So PV of the return = x*6250/1.1 + x * 0.75*6250/1.1^2 + x * 0.75^2 * 6250/1.1^3 + ... to infinity

= x * 6250 / 1.1 * 1 / (1-0.75/1.1) = x * 17857.14

For the investment to make sense, x * 17857.14 > 600,000

or x > 33.6 ~34

So at least 34 new clients are needed to get the expense to payoff in the long term.

2. PV of Current Retention Rate = 500*6250/1.1 + 500 * 0.75*6250/1.1^2 + 500 * 0.75^2 * 6250/1.1^3 + ... to infinity

= 17857.14 * 500

If Retention Rate is increased to 76%, PV = 500*6250/1.1 + 500 * 0.76*6250/1.1^2 + 500 * 0.76^2 * 6250/1.1^3 + ... to infinity = 500 * 6250 / 1.1 * 1 / (1-0.76/1.1) = 18382.35 * 500

So maximum amount that can be paid = 18382.35 * 500 - 17857.14 * 500 = $262,605

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