Applications of DatabasesApplications of DatabasesMarketing in B2C and B2B ScenariosMarketing in B2C and B2B Scenarios

Paul J.C. Chang | Eneida Lau | Ximena Salazar | Lester Arellano | José-Pablo González |Edith Quispe

ContentsContents

OverviewOverview Customer Value-A decision MetricCustomer Value-A decision Metric Study 1: The Lifetime-Probability Study 1: The Lifetime-Probability

Relationship in a Noncontractual settingRelationship in a Noncontractual setting Study 2: A Model for Incorporating Study 2: A Model for Incorporating

Customer’s Projected Profitability into Customer’s Projected Profitability into Lifetime Duration ComputationLifetime Duration Computation

Study 3: A Model for Identifying the Study 3: A Model for Identifying the True Value of a Lost Customer True Value of a Lost Customer

SummarySummary

Before: Customer value to the firmBefore: Customer value to the firm

OverviewOverview

Loyalty ProgramsLoyalty Programs

Economy Class Vs Business ClassEconomy Class Vs Business Class

Nowadays: Recognizes special customersNowadays: Recognizes special customers

The redemption is based The redemption is based on the year, make or modelon the year, make or model of the car or truckof the car or truck

OverviewOverview

Firms don’t use surrogate measure anymoreFirms don’t use surrogate measure anymore

Customers realize they can not expect a firm to believeCustomers realize they can not expect a firm to believethey are special in they are not genuine high-value buyersthey are special in they are not genuine high-value buyers

Blend of differential levels of treatments such that over

every customer’s lifetime, the profits can be maximized

Firms are becoming profit-oriented in their approach toward customer reward programs.

Loyalty ProgramLoyalty Program

OverviewOverview

Customer value metricCustomer value metric11

22 Turning unprofitableTurning unprofitable

33 Factors that affect the profitable timeFactors that affect the profitable time

44 Marketing investmentsMarketing investments

55 Frequency on mkt elements on profitabilityFrequency on mkt elements on profitability

66 Predict the timing of purchasePredict the timing of purchase

Customer Value - A Customer Value - A Decision MetricDecision Metric

Customers to whom the firm should provide

Customers to whom the firm should provide

preferential and sometimes personal treatment?

preferential and sometimes personal treatment?

To which customers they should interact To which customers they should interact through inexpensive channels?through inexpensive channels?

Which customers to let go?

Which customers to let go?

How do firms decide the timing of an

How do firms decide the timing of an

offering?offering?A firm can decide either to adopt the customer value

metric in a step-by-step manner or integrating it as the guiding for all future marketing actions

Customer Lifetime Duration Vs.Customer Lifetime Duration Vs.Customer ProfitabilityCustomer Profitability

Database-marketing analysis in B2C and Database-marketing analysis in B2C and B2B scenarios in noncontractual B2B scenarios in noncontractual relationships.relationships.

Study 1 shows 4 propositions which are:Study 1 shows 4 propositions which are:

Stu

dy

1

1. Exists strong (+) relationship between customer lifetime duration and profitability

2. Profits increase over time

3. The cost of serving long-life customers is less

4. Long life customers pay higher prices

Factors That Affect the Profitable Factors That Affect the Profitable Lifetime Duration of CustomersLifetime Duration of Customers

Identify three indicators Identify three indicators Comparison of past metricsComparison of past metrics

RecencyRecency FrequencyFrequency Monetary ValueMonetary Value

Illustration of superiority of the Illustration of superiority of the proposed metricproposed metric

Stu

dy

2

Key implications in CRM

Identifying the True Value Identifying the True Value of a Lost Customerof a Lost Customer

Impact of a lost customers on Impact of a lost customers on the profitabilitythe profitability

Value of a lost customers Value of a lost customers changes throughout the product changes throughout the product life cyclelife cycle

Stu

dy

3

Lifetime Vs. ProfitabilityLifetime Vs. ProfitabilityStudy 1Study 1

Background and ObjectiveBackground and Objective

Long customer relationships or short Long customer relationships or short term customer relationshipsterm customer relationships

Marketing payoff Marketing payoff

“In short, the contention that loyalcustomers are always more

profitable is a gross oversimplification”

Cost of serving loyal customersCost of serving loyal customers How much pay loyal customers? How much pay loyal customers? How much time spend loyal customers?How much time spend loyal customers?

Contractual settings Vs NoncontractualContractual settings Vs Noncontractual 14 billion of catalogs are mailed. Its sales 14 billion of catalogs are mailed. Its sales

increased at more that twice the rate of increased at more that twice the rate of overall retail salesoverall retail sales

In 1998 direct marketing reach In 1998 direct marketing reach $1.4trillion $1.4trillion

Background and ObjectiveBackground and Objective

Customer Portfolios

-TimeTime-Longer intervals: More Purchases?Longer intervals: More Purchases?-Investments?Investments?

Non Contractual Non Contractual settingssettings

Proposition 1Proposition 1

Long term relationships are Long term relationships are more profitable for the firmmore profitable for the firm

The Nature of the Lifetime-Profitability Relationship is Positive

Contractual Firms

Non Contractual FirmsNon Contractual Firms

The cost of satisfying customers The cost of satisfying customers exceed the profit margin exceed the profit margin offered by the customeroffered by the customer

Customers could buy less from Customers could buy less from the catalogue because the the catalogue because the competition, limited spending, competition, limited spending, etc.etc.

Customer’s PartitionCustomer’s Partition

Firms should partition customers into Firms should partition customers into behaviorally and attitudinally behaviorally and attitudinally homogeneous groups homogeneous groups

Segment2

Segment1

Segment4

Segment3

Lifetime revenueLow High

Life

time

dura

tion

Short

Long

Proposition 2Proposition 2

Noncontractual situation: A Noncontractual situation: A customer may buy once a year and customer may buy once a year and spending a small amount.spending a small amount.

Profits Increase over the Time

Costs of serving longlife customers are higherCosts of serving longlife customers are higher

Profits for the firm does not increase over timeProfits for the firm does not increase over time

The costs of promoting to a The costs of promoting to a customer, in relation to her customer, in relation to her revenues, is lower for long-life revenues, is lower for long-life customerscustomers

PropositionProposition 3 3

The Costs of Serving Longer-life Customers Are Lower

Proposition 4Proposition 4

Longer-life Customers Pay Higher Prices

Existing customers pay effectively Existing customers pay effectively higher prices that new ones.higher prices that new ones.

Managers said the opposite Managers said the opposite

Research MethodologyResearch Methodology

DataData

US catalog US catalog retailerretailer

Information for 3 Information for 3 yearyear

Tracked from Tracked from the very first the very first purchasepurchase

The ProcessThe Process

Negative Binomial DistributionNegative Binomial Distribution

““Which individual customers are Which individual customers are most likely to represent the most likely to represent the active or inactive customers?”active or inactive customers?”

Lifetime EstimationLifetime Estimation

Birth date = Birth date = “first purchase”“first purchase”

Cohort 1 is 28.7 Cohort 1 is 28.7 monthsmonths

Cohort 2 is 27.9 Cohort 2 is 27.9 monthsmonths

What is a cohort?What is a cohort?

A cohort is a group of customers A cohort is a group of customers who started their relationship at who started their relationship at the same point in time the same point in time Particular month or quarterParticular month or quarter

Lifetime Determination of Lifetime Determination of Individual HouseholdIndividual Household

Profit CalculationProfit Calculation

Cohort 1:Cohort 1: Vary from $2.5 to $111.1Vary from $2.5 to $111.1 Mean = $53.3Mean = $53.3

Cohort 2:Cohort 2: Vary from $3.3 to $108.5Vary from $3.3 to $108.5 Mean = $57.6Mean = $57.6

Aggregate Profits ($) for Short-Aggregate Profits ($) for Short-life Segmentslife Segments

Aggregate Profits ($) for Long-Aggregate Profits ($) for Long-life Segmentslife Segments

Regression Analysis of Profits as a Function Regression Analysis of Profits as a Function of Timeof Time

(Table 12-3)(Table 12-3)

Dummy Coefficient CoefficientDummy Coefficient CoefficientSegment Intercept Segment Intercept (a)(a) for for tt =1 =1 (b1) (b1) for for tt (b2)(b2) R2R2

11 12.11 (12.73) 12.11 (12.73) 45.77 (46.38)45.77 (46.38) -0.13 (-0.14)-0.13 (-0.14) .85 (.85).85 (.85)

22 n.s. (n.s.) n.s. (n.s.) 30.24 (30.91)30.24 (30.91) 0.07 (0.071) 0.07 (0.071) .92 (.91).92 (.91)

33 19.40 (20.9) 19.40 (20.9) 57.85 (58.29)57.85 (58.29) -0.70 (-0.75)-0.70 (-0.75) .95 (.94).95 (.94)

44 3.25 (3.69) 3.25 (3.69) 29.53 (31.45)29.53 (31.45) -0.14 (-0.15)-0.14 (-0.15) .94 (.95).94 (.95)

Regression Results for Regression Results for tt = 1 to 36 Months (Cohort 1) = 1 to 36 Months (Cohort 1)Validation Results in Parentheses (Cohort 2)Validation Results in Parentheses (Cohort 2)

• With the exception of Segment 2, the coefficient for the linear With the exception of Segment 2, the coefficient for the linear

effect has a negative sign – highlights the negative profit trend effect has a negative sign – highlights the negative profit trend

over time for the 3 segmentsover time for the 3 segments

Are the Costs of Serving Long-Life Customers Are the Costs of Serving Long-Life Customers Lower?(pp. 261)Lower?(pp. 261)

The ratio of mailing cost per dollar sales in the longer-life segment The ratio of mailing cost per dollar sales in the longer-life segment

(Segment 1) is statistically not different from the mailing cost per (Segment 1) is statistically not different from the mailing cost per

dollar sales in the shorter-life segment (Segment 3)dollar sales in the shorter-life segment (Segment 3)

In terms of cost efficiency, Segments 1 and 3 are the most In terms of cost efficiency, Segments 1 and 3 are the most

attractive to the firm, although they have very different lifetime attractive to the firm, although they have very different lifetime

propertiesproperties

The ratio of mailing cost and revenues – which is one measure of The ratio of mailing cost and revenues – which is one measure of

efficiency – need not necessarily be lower for long-life-customers efficiency – need not necessarily be lower for long-life-customers

Do Long-Life Customers Pay Do Long-Life Customers Pay Higher Prices?Higher Prices?

(pp.261~262)(pp.261~262)

The average price per item for segment 3 is significantly (The average price per item for segment 3 is significantly ( = =

0.05) different from (and greater than) that of segment 10.05) different from (and greater than) that of segment 1

The highest average price paid for a single product item is in The highest average price paid for a single product item is in

Segment 3, the short-life segmentSegment 3, the short-life segment

The highly profitable short-term customers seem to be less The highly profitable short-term customers seem to be less

sensitive to the product’s price sensitive to the product’s price

The higher spending (average prices paid) by Segment 3 The higher spending (average prices paid) by Segment 3

customers may be due to some other benefit sought by themcustomers may be due to some other benefit sought by them

Summary of FindingsSummary of Findings

A strong linear positive association between lifetime and A strong linear positive association between lifetime and

profits does not necessarily exist profits does not necessarily exist

A static and a dynamic lifetime-profit analysis can exhibit A static and a dynamic lifetime-profit analysis can exhibit

a much differentiated picture: profitability can occur for a much differentiated picture: profitability can occur for

the firm from high the firm from high andand low lifetime customers low lifetime customers

Profits do not increase with increasing customer tenure: Profits do not increase with increasing customer tenure: the cost of serving long-life customers is not lower the cost of serving long-life customers is not lower

Long-life customers do not pay higher prices Long-life customers do not pay higher prices

A Model for Incorporating Customers’ A Model for Incorporating Customers’ Projected Profitability into Lifetime Projected Profitability into Lifetime Duration ComputationDuration Computation

Study 2Study 2

Key research tasks:Key research tasks:

Empirically measure lifetime duration Empirically measure lifetime duration for noncontractual customer-firm for noncontractual customer-firm relationships, incorporating projected relationships, incorporating projected profits.profits.

Understand the structure of Understand the structure of profitable relationships and test the profitable relationships and test the factors which impact a customer’s factors which impact a customer’s profitable lifetime duration.profitable lifetime duration.

Develop managerial implications for Develop managerial implications for building and managing profitable building and managing profitable relationship exchangesrelationship exchanges

Research MethodologyResearch Methodology

Direct marketing industryDirect marketing industry Results validated customer Results validated customer

sample high-tech firmsample high-tech firm

Mar-95Mar-95    Cohort 3Cohort 3 2835 observations2835 observations

Feb-95Feb-95       Cohort 2Cohort 2 4895 observations4895 observations Dec 97Dec 97

Jan 95Jan 95          Cohort 1Cohort 1 4202 observations4202 observations

start finish

Alive Probability Alive Probability

NPV NPV

18

1 1

1*)(

t

tn

n

itinit rAMCMAlivePECM

NPVNPV

Decision RuleDecision Rule

NPV of NPV of ECMitECMit

Cost of marketing Cost of marketing interventionintervention

<<

18

1 1

1*)(

t

tn

n

itinit rAMCMAlivePECM

ECM ECM estimated expected contribution margin for customer estimated expected contribution margin for customer i i

AMCM AMCM average contribution margin in month t based on prior average contribution margin in month t based on prior purchases,purchases,

updated monthlyupdated monthly

rr discount rate (15% yearly)discount rate (15% yearly)

ii customercustomer

tt month for which NPV is calculatedmonth for which NPV is calculated

nn number of monthsnumber of months

P(alive)P(alive) probability of customer i to be alive in month nprobability of customer i to be alive in month n

Profitable lifetime = Profitable lifetime = f(Exchange characteristic, f(Exchange characteristic, customer heterogeneity)customer heterogeneity)

Main drivers of customer’s profitable lifetime Main drivers of customer’s profitable lifetime durationduration

itxi ethth )()( 0

Hazard ModelHazard Model

Independent variablesIndependent variables Purchase amountPurchase amount Cross buyingCross buying Focus of buyingFocus of buying Average interpurchaseAverage interpurchase ReturnsReturns Loyalty instrument (ownership of Loyalty instrument (ownership of

charge card)charge card) MailingsMailings Product categoryProduct category Population densityPopulation density IncomeIncome AgeAge

ResultsResults

A Model for Identifying the True A Model for Identifying the True Value of a Lost CustomerValue of a Lost Customer

Customer Defection Customer Defection Disadoption by ContrastDisadoption by Contrast

This affects the long term profitability in two This affects the long term profitability in two ways, one is the loss of direct sales and the ways, one is the loss of direct sales and the other is in term of indirect effects of word of other is in term of indirect effects of word of mouth, imitation.mouth, imitation.

Modeling the Effects of Disadoption Modeling the Effects of Disadoption on the Value of Lost Customeron the Value of Lost Customer

VCL = VCL = VCL VCLdisadopter disadopter – (1 - – (1 - )VCL)VCLdefectiondefection

= proportion of disadopters in a firm’s = proportion of disadopters in a firm’s lost customerslost customers

VLC = Value of an average lost customerVLC = Value of an average lost customer

The Key Determinants of the The Key Determinants of the Value of a Lost CustomerValue of a Lost Customer

To study the phenomenon of the lost customer, a Monte To study the phenomenon of the lost customer, a Monte Carlo simulation was used in which the key parameters Carlo simulation was used in which the key parameters such as external influencesuch as external influence

Estimation of P (Alive)Estimation of P (Alive)

How to calculate the Likelihood of How to calculate the Likelihood of customer being alivecustomer being alive Methods of the momentMethods of the moment Maximum Likelihood Estimation (MLE)Maximum Likelihood Estimation (MLE)

Requires Cohort of customersRequires Cohort of customers Goal: find the probability of a Goal: find the probability of a

customer (transaction history) being customer (transaction history) being alive. alive.

The true Value of The true Value of a Lost Customer VLCa Lost Customer VLC

Indirect Social Effects (+- word Indirect Social Effects (+- word of mouth, etc)of mouth, etc) misallocations misallocations of MKT efforts (strategies)of MKT efforts (strategies)

VLC depends on customer VLC depends on customer defection (goes to another defection (goes to another company) and loyalty. company) and loyalty. Sales Sales Disadoption Disadoption

Modeling Disadoption on Modeling Disadoption on VLCVLC

VLC= (alpha) VLC disadopters + VLC= (alpha) VLC disadopters + (1- alpha) VLC defectors. (1- alpha) VLC defectors.

Key Determinants Key Determinants Internal Influence (+ word of Internal Influence (+ word of

mouth)mouth) External Influence External Influence Disadoption timeDisadoption time

SummarySummary

Study of lifetime probabilityStudy of lifetime probability Conceptual Model Conceptual Model Non contractual ScenarioNon contractual Scenario

Lower Priced Items Vs Established name Lower Priced Items Vs Established name brand products.brand products.

The objectives of the second study:The objectives of the second study: Measure lifetime durationMeasure lifetime duration Incorporate projected profits into the Incorporate projected profits into the

relationship modelrelationship model Develop managerial implications Develop managerial implications

Spending level, cross buying, etc. Spending level, cross buying, etc.

SummarySummary

The third model (VLC) The third model (VLC) Determine the effects of Determine the effects of

disadoption on the value of lost disadoption on the value of lost customers. (direct & Indirect customers. (direct & Indirect effects)effects) Disadoption time: ei. Has the Disadoption time: ei. Has the

maximum negative impact on the maximum negative impact on the value. The earlier a customer value. The earlier a customer disadopts, the higher the value of the disadopts, the higher the value of the lost customer. lost customer.