CRM Analytics PDF

BEP386
CHAPTER SEVEN
Customer Relationship Management

Analytics
From Relationship Marketing Re-Imagined:

Marketing’s Inevitable Shift from Exchanges
to Value Cocreating Relationships
By Naresh K. Malhotra, Can Uslay, and Ahmet Bayraktar

(A Business Expert Press Book)
Copyright © Business Expert Press, LLC, 2016. All rights reserved.
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This document is authorized for use only in DR.ABHA WANKHEDE's PGDM-MKT/ MMS-MKT 21.01.2019 at Somaiya Vidyavihar from Jan 2019 to Jul 2019.
CHAPTER 7
Customer Relationship
Management Analytics
Introduction
This chapter introduces the role and benefits of customer relationship
management (CRM) and the historical development of the CRM
concept. In addition, it discusses how to measure and manage customer
value and customer lifetime value (CLV) by presenting various approaches
and principles. Besides, it introduces two types of strategies, namely,
“across-customer” strategies and “within-customer” strategies, which help
companies maximize CLV. The chapter also discusses the importance of
CLV-based marketing initiatives, which channel firms’ efforts toward cus-
tomer-centric marketing and away from product orientation. After intro-
ducing CRM solution providers, the chapter concludes with two cases
that illustrate how CRM technologies can help firms grow their business
and play a key role in achieving long-term success by transforming the
whole company.
Are Loyal Customers Profitable Customers?

Behavior loyalty is not a very good predictor of retention and represents
an even worse predictor of customer satisfaction. For example, customers
under service contracts can appear to be loyal for the duration of the con-
tract but switch to a competitor with better pricing as soon as the contract
expires. Satisfaction is a matter of meeting or exceeding past expectations;
however, loyalty also includes an expectation of future actions.1 There-
fore, the two do not always go hand in hand. According to one study,
75 percent of consumer wireless phone service customers were found to
be satisfied, but 72 percent would be willing to switch to a competitor.2
This document is authorized for use only in DR.ABHA WANKHEDE's PGDM-MKT/ MMS-MKT 21.01.2019 at Somaiya Vidyavihar from Jan 2019 to
Jul 2019.
104 RELATIONSHIP MARKETING RE-IMAGINED
Even attitudinal loyalty may not necessarily reflect in profitability.

A customer may be really happy with a BMW that he or she purchased
at a year-end sale and have very favorable expressed loyalty toward the
brand. However, that becomes much less meaningful to the company if
the customer enjoys the car for some 20 years and never gets it serviced at
a BMW dealer once the warranty expires. These nuances underline why
CRM applications have become increasingly important during the past
three decades.
Effective CRM Strategy and Measurement
The former Union Trust Bank in San Francisco, now Wells Fargo.
Firms such as Wells-Fargo Bank have invested millions of dollars for
hardware as well as employee training to effectively manage their
customer relationships in order to maximize their profits.
Source: Wikimedia by Kjteil Ree.
The CRM process begins with customer selection (based on the mission
statement of the firm), developing the value proposition to serve them,
monitoring nonfinancial metrics of performance, and finally making sure
that these metrics are ultimately reflected in financial performance, that
is, customer profitability. However, in many cases, switching from mass to
relationship marketing may also require a transformation of the culture of
the firm from the top all the way to the bottom. The technical aspects of
CRM, although expensive, are relatively easy to handle. It is the human
Jul 2019.
Customer Relationship Management Analytics 105
aspects of the CRM transformation that is challenging and time consum-

ing in developed as well as developing nations.3
The primary advantages of CRM over mass and direct marketing
include the ability to increase customer satisfaction, effective reach, auto-
mation, contextual individualization, and experience-based branding. Its
disadvantages include high organizational involvement and costs.4
Once properly implemented, the benefits of CRM are numerous:
• CRM enables the marketer to measure and manage to opti-

mize the cost to serve customers. Metrics can be tracked at the
individual level.
• It empowers the firm to determine which customers are not
profitable and “outsource” them if necessary. There is no
need to serve a persistently unprofitable customer with poor
strategic prospects.
• CRM marketers can conduct marketing experiments by
sampling from different categories and measure impact across
groups. This allows for fine-tuning of marketing campaigns at
relatively low cost.
• CRM enables the measurement of return on marketing
investment (ROMI). Campaigns enabled by CRM are more
target-oriented and have a better impact.
• Thus, CRM increases customer retention as well as customer
acquisition.
• CRM is a dynamic learning system and becomes more effec-
tive with more data.5
In order to serve the customers effectively, it is important to recognize

that customer relationships are dynamic and evolve over time. The rela-
tionships can be functional, structural, and strategic in nature and mar-
keters need to actively pursue customers to build relationships with them.
Point to Ponder: Consider the following definition of CRM from The

Wall Street Journal:
Customer Relationship Management (CRM): The process of

storing and analyzing the vast amounts of data produced by
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sales calls, customer-service centers and actual purchases, sup-

posedly yielding greater insight into customer behavior. CRM
also allows businesses to treat different types of customers
differently—in some cases, for instance, by responding more
slowly to those who spend less or charging more to those who
require more extensive handholding.6
What do you think of this definition?
Historical Development of CRM

Although relationship marketing and CRM are often used interchange-
ably, CRM typically refers to the technology-based solution domain of
relationship marketing, often confused with CRM technology by itself.7
It has been used to refer to a wide array of applications, including sales
force automation, direct mail campaigns, loyalty programs or databases,
and help desk or call center. To some
it was about populating a data warehouse or undertaking data

mining; others considered CRM an e-commerce solution, such as
the use of a personalization engine on the Internet or a relational
database for Sales Force Automation. This lack of a widely accepted
and appropriate definition of CRM can contribute to the failure of
a CRM project when an organization views CRM from a limited
technology perspective or undertakes CRM on a fragmented basis.8
To add to the confusion, at least a dozen definitions of CRM have

been proposed. We adopt and advocate the following definition: “CRM
is a comprehensive strategy and process of acquiring, retaining, and part-
nering with selective customers to create superior value for the company
and the customer.”9 Additional features of ideal CRM are that it embraces
e-commerce, disseminates through the whole organization, promotes
and requires long-term vision, enables customization, and is data driven,
information intensive, and outcome oriented.
Having said all this, the following three main assumptions about
long-life (behaviorally loyal) customers have been tested but found to be
Jul 2019.
unfounded: (a) the costs of serving long-life customers are less, (b) they
pay higher price premiums, and (c) they spend more. Therefore, behav-
iorally loyal customers are not necessarily more profitable than other cus-
tomers.10 Firms need to be able to differentiate their customers by their
(current and potential, long term) value and implement CRM initiatives
that are aligned with providing the customer better value.
Small volume customers can be profitably reached via direct market-
ing campaigns. A well-crafted direct marketing campaign is not wasteful
but can be very effective. For example, Dell considers their direct mar-
keting skills as a key competitive advantage, more so than their products
and manufacturing.11 Customer value is not built one transaction at a
time but rather through a series of mutually successful episodes. Some
episodes will inevitably include failures. The way the firm handles these
failures and recovers from them can create even more loyal and devoted
customers. Yet, roughly half of the customers with complaints are not
happy with the way companies handle their complaints.12 In the airline
industry, it has been shown that customer complaints can destroy firm
value more than satisfaction contributes to it.13
Point to Ponder: Why do you think that CRM strategies are successful?
Point to Ponder: What is the difference between brand management

and CRM?
Measuring and Managing Customer Value

For many firms, the 80:20 rule has become even more skewed and only a
few of their customers may generate most of their revenues and almost all
of their profits. For such firms, management of key accounts is vital. Each
relationship must be cultivated and developed, and hopefully cemented
over time. Alas, even the firms who have long segmented their customers
into value categories have not been doing a good job of it. For example,
with the exception of the top 10 percent of fliers, the assigned category
tiers do not correlate with the customers’ true values in the frequent-flier
databases.14 Poor implementation and lack of appropriate technology are
the two main causes of this recurring problem.
Jul 2019.
Various metrics are available for measuring the value of the customer
and implementing the CRM strategies. Some traditionally used metrics are
recency–frequency–monetary (RFM) value, share of wallet (SOW), and
past customer value (PCV). These existing metrics have several limitations
and do not link the value of a customer to future profitability. On the other
hand, CLV is an advanced metric that is widely gaining popularity across
all sectors and industries. The forward-looking CLV metric considers the
future value of a customer to the firm and aids in designing and implement-
ing marketing strategies for the present, thus maximizing profitability.15
RFM Approach
On the basis of the assumption that past purchase behavior of custom-
ers better predicts their future purchases than demographic data, RFM
scoring models have been used in marketing for more than four decades.
Historically, the initial applications were in business-to-consumer (B2C)
contexts: direct marketing, insurance, banking, telecommunications, and
so on. The customers are ranked based on their R, F, and M score. Recent
purchasers, frequent purchasers and big spenders, on average, receive
higher scores. The higher the score is, the more profitable is the customer,
which is expected to continue in the future. A basic ranking, within par-
ent cell ranking, or weighed cell ranking can be used.
In basic RFM, the customers are scored on each factor separately. That
is, the customers are ranked based on the recency of their purchases and
then split into subgroups (e.g., quintiles). As a result, there could be five
quintiles where the top quintile represents the 20 percent that has made
the most recent purchases. The procedure is then repeated for frequency
and total money spent and reveals 5 × 5 × 5 = 125 cells from highest to
lowest ranking.
Within parent cell ranking, the cells are grouped based on recency,
similar to the basic approach. However, each group is then subgrouped
based on frequency (rather than separately). Each of the resulting 25 cells
is finally ranked by monetary value. This approach requires more sorting
than the former.
In weighed cell ranking, weights are assigned to the metrics and sorted
accordingly. These weights can be equal; however, an often used weight
scheme is: (3 × R) + (2 × F) + (1 × M). The weights used depend on the
Jul 2019.
data and specific application. For example, based on the response rate, M
may turn out to be the most important factor in some cases.16
Share of Wallet
SOW refers to the share of a company of a customer’s expenditure for
a given offering category. Although market share has been shown to
uniquely impact the financial performance of the firms based on their
strategy types,17 and market share and SOW are linked, targeted efforts
to increase the share of large wallet customers can have more direct and
positive bottom line impact. For example, major casinos “comp” their
high rollers (or “whales”) with the hope to attract them to gamble in
their facilities whenever they visit, that is, they hope to attract close to
100 percent share of gambling wallet. In other cases, firms target much
smaller shares. A local restaurant would be happy to consume $50 a week
of the dining wallet of a customer who spends $600 a month ($50 × 4
weeks/$600 = roughly 33% share of dining wallet). The data is typically
acquired through primary surveys, which is then combined with other
predictors of behavior in a database (behavioral and demographic vari-
ables) and share-of-wallet is then modeled as the dependent variable.
Sj
Share-of-Wallet:
∑ j =1 Sj
J
where S is the actual sales to the focal customer, J refers to firm in cate-
gory, and the denominator represents the value of sales made by all firms
to the focal customer.
Point to Ponder: Are there cases where it is possible to conduct SOW

analysis without having conducted survey research?
Past Customer Value

The simple logic behind the PCV approach is that history is the best
predictor of future. The model uses extrapolation on the previous trans-
actions of a customer (i.e., past profits) to predict the customer’s future
value. Time value of money is used to adjust previous contributions and
calculate PCV for each customer. It can be calculated as
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PCV = ∑ t =1GCit * (1 + d )
T t
where i is the customer, d is the applicable discount rate, T is the number

of periods prior to the current period, and GCit is the gross contribution
of the transaction of customer i in time t.
For example, let’s assume that a customer spent $60 (last month), and
$100, $110, $190, and $210 (in preceding months) on his or her cable
TV bundle package. Assuming an average gross contribution margin of
50 percent and a discount rate of 12 percent per annum, we can calculate
the PCV of the customer as follows:
GC = 50% × spending amount
PCV Score = $30 × (1 + 0.01) + $50 × (1 + 0.01)2 + 55 × (1 + 0.01)3

+ 95 × (1 + 0.01)4 + 105 × (1 + 0.01)5 = $343.19
Repeating the exercise for all the customers in the portfolio would
enable prioritization of all customers and allocation of marketing
resources based on their values.
Comparing the Traditional Measures to CLV

As mentioned in the beginning of this section, RFM is a relatively simple,
traditional technique that is relatively low cost. Its data requirements are
relatively low, and it provides positive return on investment (ROI). How-
ever, it is important to provide an understanding of more sophisticated
models, because RFM is currently considered to be an outdated tech-
nique. For example, it has been shown that CLV approach is generally
superior to RFM. The top 5 percent of CLV rankings provide 1.6 times
the net profits than the top 5 percent of RFM rankings, and profitability
improves by as much as 67 percent.18 Nevertheless, recency of purchases
has been shown to be linked to CLV in a nonlinear S-shaped form.19
A drawback of the SOW approach is that it may put too much emphasis
on maximizing SOW, whereas this may not be the best long term objec-
tive for both the business and the customer. Excessive SOW and commu-
nications to maximize it may induce retaliatory variety-seeking behavior
Jul 2019.
in B2C or antitrust concerns in business-to-business (B2B) contexts.

Furthermore, PCV and other techniques do not take expected customer
activity into account. They simply extrapolate based on previous activity
and do not consider future account maintenance costs.
Point to Ponder: Can you provide a ranking of the effectiveness of the

metrics discussed so far? What are the pros and cons of each?
A Primer on CLV
A main advantage of CLV approach is that it incorporates not only the
future expected value of a customer but also the probability of that customer
remaining active in future. In contrast with the former methods, CLV
enables optimal allocation of resources at the individual customer level.
Segment-Wise Calculation of CLV
In the simplest sense, if we assign (assume) a value to the revenue gener-

ated by a customer and the cost of serving that customer, we can derive
the margin that the customer contributes to the bottom line of the firm
in a given time frame (typically a year).
CLV = ∑ t =1
T ( pt − ct ) rt − AC
(1 + d )t
where
T is the time horizon for the calculations

pt is the price paid by the customer at time t
ct is the cost of serving the customer at time t
rt is the probability of customer repeat purchase at time t
d is the discount rate or cost of capital for the firm
AC is the customer acquisition cost
Let’s consider the case of a subscription magazine targeting college

students. Assume that the average subscription lasts four years, annual
margin per subscriber is $12, annual retention rate is 90 percent, sub-
scriber acquisition cost is $20, and the interest rate is 5 percent. Using
Jul 2019.
the above formula, estimated lifetime value (LTV) of a subscriber would

be merely $18.30.
However, let’s assume that the magazine has a loyal following that
extends beyond college years. In this case, we can assume that the margin
(M) is fixed over time, and simplify the LTV formula by assuming that
the life cycle is infinite (i.e., N  ∞). Thus, the basic CLV equation for
infinite economic life becomes
∞ mr t r
CLV = ∑ =m − AC
t =0 (1 + d ) t
1− r + d
In this scenario, the LTV per subscriber of the magazine is signifi-

cantly higher, $72 − $20 = $52.
Assuming an infinite lifetime cycle and constant retention rate, we
can compute margin multiples (see Table 7.1). For example, with 95 per-
cent retention and 5 percent discount rate, CLV is 9.5 times the margin
per customer, whereas with 65 percent retention and 12.5 percent dis-
count rate, it is only 1.37 times the margin.
It has been estimated that a 5 percent increase in customer retention
improves profitability by 25 to 100 percent! Given the prominence of r in
the above equation, it is not hard to imagine how this dramatic effect comes
about. Some (but not all) retained customers may pay price premiums, buy
more, generate positive word of mouth, and enable cost savings (may cost
less to serve and decrease overall acquisition costs).20 For example, Harrah
reported that its loyalty program improved its share of gambling wallet
from 36 to 53 percent; it also increased the slot revenue by 12 percent by
using its CRM database to redesign the casino floor. In the process, it also
increased its occupancy rates and revenue from top-tier guests.21
Table 7.1 The margin multiple

Retention rate (r) Discount rate (i)
5% 7.5% 10% 12.5%
65% 1.6 1.53 1.44 1.37
75% 2.50 2.31 2.15 2.00
85% 4.25 3.77 3.4 3.09
95% 9.5 7.6 6.34 5.42
Source: Adapted from Gupta and Lehmann (2008).
Jul 2019.
The margin (m) has been found to be relatively stable over time.22
However, we can also incorporate a growth rate to the equation (assuming
1 + i is larger than r(1 + g)):
r
CLV = m
1 + i − r (1 + g )
Instead of an infinite life, the expected lifetime of the customer

(i.e., 1/(1 − r)) may also be used for estimating CLV. For example, with
90 percent retention rate, the expected lifetime is 10 years. Although
simple and straightforward, it has been shown that the expected lifetime
approach overestimates CLV.23
Advanced Measurement of CLV

The CLV models presented above make several simplifying assumptions.
For example, the retention rate is constant and applies equally to the
customer groups. However, in many cases, retention probability changes
drastically from one customer (segment) to another customer (segment)
and should not be averaged across customers. Generally speaking, mak-
ing the models more realistic means making them more complex. For
example, when we account for returns on acquisition, retention, and
add-on selling, we observe24
I  ∞  k 
CE(t ) = ∑  N i ,t ai ,t (Si ,t − ci ,t ) − N i ,t Bi ,a,t + ∑N i ,t ai ,t  ∏ ri ,t + k 
i =0
 k =1  j =1 
k
 1  
( Si ,t + k − ci ,t + k − Bi ,r ,t + k − Bi , AO , t + k 
) 
 1 + d  

where
CE(t) is the customer equity value for customer acquired at time t

Ni,t is the number of potential customers at time t for segment i
ai,t is the acquisition probability at time t for segment i
ri,t is the retention probability at time t for a customer in segment i
Bi,a,t is the marketing cost per prospect (N) for acquiring customer at
time t, segment i
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Bi,r,t is the marketing in time period t for retained customers for

segment i
Bi,AO,t is the marketing costs in time period t for add-on selling for
segment i
d is the discount rate
Si,t is the sales of the product or services offered by the firm at time t
for segment i
Ci,t is the cost of goods at time t for segment i
I is the number of segments
J is the segment designation
t0 is the initial time period
k is future time period counter
The average CLV can then be calculated by dividing CE by the total

number of customers. Average CLV metric is useful to evaluate the com-
petitors (good estimates of competitor CLVs can be calculated based on
publicly available data) and can also be used as a proxy of a firm’s market
valuation for high growth companies. However, it does not render itself
for one-to-one marketing approaches at the individual level.25
Point to Ponder: The Thomas family, an older empty nest couple,

who normally take domestic trips for vacation, decided to fly around
the world on a special promotion and spent $6,900 on fares. On the
other hand, the Arjona family, a middle-aged couple with no kids,
usually takes one international trip to their home country a year and
spends $900 on airfares. If you are a travel agent serving both families,
should the Thomas or Arjona family have priority in your market-
ing efforts for the next five years? Which effort would generate more
immediate returns? Explain. (Assume that the domestic travel profile
of the families is equivalent.)
Individual CLV Calculation

The calculation of CLV includes determining the (time-adjusted) future
contribution margin, future costs, and customer retention. In the follow-
ing section, we discuss the components and the method of calculating
contribution margin and future costs. Expressed in general form, CLV is
Jul 2019.
Future Contribution Margin it − Future Cost it

CLVi = ∑ t =1
T
(1 + d )t
where
i is the customer index,

t is the time index,
T is the forecast horizon
In contrast with contractual setting where prediction of the customer

retention metric is emphasized, the focus is on predicting future customer
behavior and contribution margin in noncontractual settings (where cus-
tomer defection rates are significantly higher).26
P(Active) refers to the probability that a customer continues to pur-
chase from the firm in the future. This is calculated at the unique indi-
vidual level in contrast with the aggregate retention rate. The net present
value (NPV) of expected gross contribution (EGC) can be calculated
as27
t +x AMGCit
NPV of EGCit = ∑ n =t +1 P ( Active)in ×
(1 + d )n
where
AMGCit is the average gross contribution margin in period t based on

all prior purchases
i is the customer index
t is the period for which NPV is being estimated
n is the number of periods beyond t
P(Active)in is the probability that customer i is active in period n
As an example, let’s use the example of a customer who spends $60,

$100, $110, $190, and most recently, $210 on his or her cable bundle
package, respectively. Assuming an average gross contribution margin of
50 percent, a discount rate of 12 percent per annum, and the probability
Jul 2019.
of the customer remaining active is 50 percent for the next month and
35 percent for the month after that, we can calculate the NPV of EGC
as follows:
AMGC = (60 + 100 + 110 + 190 + 210)/5 = $134
134 134
NPV of EGC = 0.5 × + 0.3 = $105.7445
(1 + 0.01) 1
(1 + 0.01)2
P(Active) is calculated based on frequency and time between pur-
chases. That is,
n
T 
P ( Active ) =  
N
where
n is the number of purchases made during the observation period

T is the time between first and last purchase
N is the time between first and focal period for prediction
For example, consider the following purchase schedule by three cus-

tomers (Table 7.2).
If we want to estimate P(Active) for week 10,
2
5
P(Active)Ali =   = 0.25
 10 
2
5
P(Active)Ben =   = 0.31
 9
5
6
P(Active)Charlize =   = 0.08
 10 
Table 7.2 Purchase frequency of three customers

Customers Week Week Week Week Week Week Week Week Week Week
1 2 3 4 5 6 7 8 9 10
Ali 1 1
Ben 1 1
Charlize 1 1 1 1 1
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On the basis of previous purchase frequency patterns of Ali and Ben,

it would not be unlikely for them to make a purchase during week 10.
However, Charlize, who was previously the most active, has not purchased
in a while and is not likely to purchase in the future. Ali is about three
times more likely to remain an active customer than Charlize. The basic
equation to calculate P(Active) can certainly be improved and customized
to serve a particular context better.
Marketing cost usually leads the market response (sales and profits).
Therefore, assuming that marketing costs take place in the beginning of a
period and that gross contribution is observed at the end of a period, CLV
formula can be stated as
t +x x n −1
AMGC  1 
CLVi = ∑ P ( Active)in × (1 + d )nit − ∑Min ×  1 + d  − AC
n = t +1 n =1
Assumptions of the model include that when a customer defects, he

or she does not return (customers who return after defection are treated
as a new customer by the model). This is also called as “lost for good”
scenario. Naturally, this is not necessarily true in the real world, and
the model underestimates CLV. To incorporate the possibility of a cus-
tomer coming back and enable a second LTV, predicted frequency can be
included in the CLV model:28
Ti CMi , y n
∑ mci ,m,l × xi ,m,l
CLVi = ∑ (1 + r ) y −∑
(1 + d )l −1
y =1 l =1
frequency i
where
CLVi is the LTV of customer i

CMi,y is the predicted contribution margin from customer i in pur-
chase occasion y
ci,m,l is the unit marketing cost for customer i in channel m in year l
xi,m,l is the number of contacts to customer i in channel m in year l
frequencyi is the predicted purchase frequency for customer i
n is the number of years to forecast
Ti is the predicted number of purchases by customer i until the end
of planning period
Jul 2019.
Rust, Zeithaml, and Lemon CLV Model

This model adopts the notion that a portion of the dormant customers
can return and make purchases.29 The utility model incorporates for both
CLV drivers and brand inertia.
Uijk = b0k LASTijk + Xik b1k + ε ijk
where
b0k is the logit regression coefficient for inertia

b1k is the column vector of logit regression coefficients corresponding
to the drivers
ε ijk is the random error term with double exponential distribution
The individual choice probability for customer i is modeled as
Pijk* = Pr (customer i chooses brand k*, given that brand j

was chosen most recently) = exp(U ijk ∗ )
∑ k exp(U ijk )
Customer switching is modeled based on Markov J × J matrix where J
is the number of brands, and switching probabilities is pijk, where customer
i having recently purchases brand j purchases brand k on next purchase.
Tij −t
f ivijt pijt Bijt
CLVij = ∑(1 + d j )
t =0
where
Tij is the number of purchases customer i is expected to make before

firm j’s time horizon
Bijt is a firm specific element of Bit
So CEj = meani(CLVij) × total number of customers in the market and
CE j
CES j =
∑ kCEk
Additional advanced models for customer retention are presented in
Table 7.3.
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Table 7.3 Models of customer retention
Models of Representation Remarks

customer
retention
Logit or probit X represents the covari-
1
models P (Churn ) = ates; commonly used
1 + exp( β X ) in industry because of
simplicity
Hazard models t is the purchase
with acceler-
ln t j = β j X j + σµ j
( ) duration for customer
ated failure j and X represents the
time (AFT) covariates
Generalized g α and γg are shape
 t jj 
gamma hazard −  parameters and λlj is
g a g −1  l j 
model f (t jk ) = t
a g jk
e the scale parameter for
Γ(a )l customer j. lj varies
across customers with
an inverse generalized
gamma distribution
Proportional l is the hazard rate
λ (t ; X ) = λ0 (t ) exp( β X )
hazard models specified as a function of
the baseline hazard rate
l0 and covariates (X)
Pareto/NBD P ( alive|r , a , s , b , X = x , t ,T ) R and α gamma distri-
probability bution parameters for
model29 customer heterogeneity
 s
r +
 a + T   b + T 
x s
= 1 + in transactions; s and
   
 r + x + s  a + t   a + t  b for dropout rates; x
is the number of past
s transactions of the
 b +T 
()
F ( a1 , b1 ; c1 , z1 t ) − 
 a +t   customer; t is the time
since trial and the most
−1 recent transaction; T is
  time since trial and F is
( )
F ( a1 , b1 ; c1 , z1 T   the Gauss hypergeomet-
  ric function
Markov’s t V′ is the vector of CLV,

V ′ = ∑ t = 0 (1 + i ) P  R
T −1
model P is the transition
 
probability matrix, R is
the margin vector (both
assumed constant over
time)
Source: Adapted from Gupta and Lehmann (2008).
Jul 2019.
Point to Ponder: Which model has the most realistic assumptions?

How are they different from one another?
Strategies for Maximizing CLV

In order to maximize CLV, companies can follow two types of strate-
gies: “across-customer” and “within-customer”. Across-customer strat-
egies involve (a) efficient customer selection by targeting customers
with high profit potential, (b) managing existing set of customers and
rewarding them based on their profit potential, and (c) monitoring cus-
tomer behavior and making timely interventions to prevent attrition and
thereby ensuring future profitability. “Within-customer” strategies aim at
maximizing profits by increasing the revenue or reducing the cost or by
doing both. The “within-customer” strategies are promoting multichan-
nel shopping (revenue maximization), optimizing allocation of resources
(cost reduction), and managing the purchase sequence of the customers
(revenue maximization and cost reduction). Maximizing the brand value
is another key “within-customer” strategy.
Customer Selection
As mentioned previously, all loyal customers are not necessarily profit-

able. It is important to identify which customers have profit potential
and focus on attracting and retaining those customers. The use of CLV
approach has been proven to be superior to other traditional methods
presented earlier for both B2B and B2C contexts.30
Managing Existing Customers
It is also appropriate to segment customers based on CLV and develop

proper marketing strategy to improve the ROI for each segment. They
can then be combined with additional demographic and other variables
to understand the reasoning behind each segment (see Figure 7.1). Dif-
ferent marketing methods maybe more suitable for different segments
from both cost and response point of view. For example, reaching the
Jul 2019.
Drivers of value: Detracters of value:

• Customer lifetime • Cost of customer
• Purchase frequency acquisition
• Purchase size • Cost of customer
• Price points retention
• Cross-buying Customer • Cost of returns
+ lifetime –
• Customer income • Cost of marketing
• Marketing activities of value (CLV) activities
firm • Discount rate
• Loyalty program • Returns
• Direct marketing
• Network effects (e.g.,
word-of-mouth)
Figure 7.1 Factors impacting customer lifetime value

Source: Adapted from Singh and Jain (2009, 39).
Butterflies True friends

• Market for more profit with each • Market and invest for best profit
High
transaction to create attitudinal and
behavioral loyalty
Profitability
Strangers Barnacles
• Ensure profit on each • Improve profitability by investing
Low
transaction; if not outsource for share of wallet when wallet is
large
Short-term Long-term
Customers
Figure 7.2 Segmentation based on customer lifetime profitability and

relationship duration
Source: Adapted from Reinartz and Kumar (2002, 93).
customer via phone call for high-CLV customers and e-mail contact
to low-CLV customers may be more justified. However, other choices
may not be as straightforward, for example, a middle-CLV category may
by-and-large prefer e-mail over direct mail because of their Internet com-
petency. This approach can also be used to develop customer profiles.
For example, Figure 7.2 categorizes customers into four groups based on
Jul 2019.
their profitability and relationship duration. There is a need to convert

“butterflies” and “barnacles” to “true friends” and make profit with each
purchase of the “strangers.”
Monitoring Customers to Allocate Resources Optimally
Some advanced models even allow for heterogeneity at the customer level.
For example, one particular high-CLV customer (whale) may refuse to be
contacted by phone at all times and only visit Las Vegas during a cer-
tain season and so on. Recent developments in modeling have enabled
marketers to estimate optimal marketing spending at the individual level.
There is a need to estimate the interpurchase duration of each customer,
cash flows from each customer, and then maximize profits accordingly.
Then the firm would know what the optimal time interval to contact a cus-
tomer is, as well as the best mode of communication with him or her. More
contact is not only costly but also not always better and can create tedium.
Given the tremendous amount of data collected by retailers, it is pos-
sible to correlate a customer’s purchases with those who have bought the
same or similar products and predict what he or she might buy next.
The more relevant the communication is, the higher is the likelihood of
the customer to respond to the communication with a purchase. There-
fore, the sequence of purchases, timing, and value of the next purchase
needs to be estimated.31
Marketing Mix Strategies
As we emphasized during the introduction, value cocreation must be the

focus of activities.
First, for products or services, the customers should be engaged in the
design, as well as the production and consumption of the service. When
this happens, mass customization should improve the CLV dramatically.
For example, NikeID Web site empowers the customers to design and
personalize their own athletic shoes. Second, value-added services help
differentiate core offerings and improve CLV.32
As for pricing, these can be adjusted based on CLV so that low-CLV
customers pay more for each transaction and others are rewarded based on
Jul 2019.
their strategic importance. Multiple channels can be used to serve high-

CLV customers to provide added convenience. Customers served through
multiple channels tend to buy more. Introducing human touch to high-
CLV customers can also improve their commitment to the relationship.
Promotional efforts must be interactive and focus on both behavioral and
attitudinal loyalty.
Value cocreation can extend to the whole spectrum: coconception

(military and defense contracts), codesign (Boeing and United
Airlines), coproduction (Ikea), copromotion (word of mouth),
copricing (eBay, negotiated pricing), codistribution (magazines),
coconsumption (utility), comaintenance (patient–doctor), codis-
posal (self-serve), and even co-outsourcing (captive business pro-
cess outsourcing). Networks that marketing interacts with to
connect structural gaps include consumer, distributor, supplier,
regulatory, and competitor networks. With this broadened
perspective, cocreation is likely to result in an aggregate optimal
value that is greater than the sum of two (or more) local optima,
as in the case of exchange.33
Point to Ponder: What strategies do you think may be relevant for an

industrial manufacturing firm?
Link Between CLV and Customer Equity to

Shareholder Value
The links between CLV and shareholder value become more obvious
once the focus of the marketing manager shifts from expense and reve-
nue to investment and assets.34 Customers respond to marketing activ-
ities through their mindset metrics such as satisfaction and attitudes,
which in turn boost firm value. Marketing actions begin with tactical
actions such as advertising and service improvements, new product
and channel introductions, and so on. Subsequently, these marketing
actions make an impact on customers, improving their attitudes and
satisfaction. These improvements are expected to lead to higher brand
Jul 2019.
and customer equity and increase sales, market share, cash flow, ROI,
and ultimately the value of the firm as measured by market capitalization
(shareholder value).35
Implementing CLV
Implementation of CLV to B2C contexts is harder, as gathering the
necessary data from all customers may be cost-prohibitive and time-
consuming. Furthermore, the firms that rely on channel intermediaries
may not be in direct contact with their customers. In fact, developments
in CRM technology and availability of computing power provide oppor-
tunities (through sampling if not for the entire customer base) for large as
well as small firms for both B2B and B2C contexts. Therefore, the context
to consider and plan for becomes B2B2C. The challenges of legacy CRM
systems and the rationale to upgrade them include their high mainte-
nance costs, minimal flexibility, limited functionality, poor integration,
and minimal analytical capabilities. For example, one European carrier
reportedly spends $2M to manage its 500,000 members using a legacy
system, that is, $4 per member every year spent just to maintain the
system. Moreover, it takes six months for the carrier to simply change
a tier requirement. The same feat takes only a day with contemporary
systems. Nevertheless, a primary reason for not successfully implement-
ing CRM is viewing it as solely a technology initiative.36
Shift from Product-Centric to Customer-Centric

Framework
We anticipate that the use of relationship marketing will become even
more prominent over time. Corporations will have CLV-based marketing
initiatives that channel their efforts toward customer-centric marketing
and away from product orientation.37 The producers will need to get to
know their end users, and such learning will reveal new horizons for value
cocreation.38 Prioritization among customers based on expected value
is a worthy goal for marketers. Interestingly, prioritization not only sig-
nificantly improves the relationships (hence the sales and profitability)
with top-tier customers but also does not negatively affect those with
Jul 2019.
bottom-tier customers. Prioritization also decreases marketing and sales

and costs, thereby increases the efficiency of the organization.39
We have discussed the many reasons why firms should engage in rela-
tionship marketing. However, the approach would not work unless the
customers find value in it as well. There are numerous personal, sociolog-
ical, and institutional factors that make relationship marketing appealing
for the customers. These include achieving greater efficiency in decision
making, simplifying the task of information processing, achieving more
cognitive consistency, reducing perceived risks associated with future
choices, adhering to norms of behavior set by family members, and influ-
ence of peer groups (i.e., social class and reference groups), government
mandates, religious tenets, employer influences, and marketer-induced
policies.40
Point to ponder: Can you think of cases where the customer does not
want to build a relationship with the marketers or brand? What are the
societal implications of abandoning relationship marketing in these
cases? Should building relationships be-all and end-all of marketing?
CRM Solution Providers

Companies such as Oracle, PeopleSoft, SAP, e.Piphany, Chordiant,
NCR Teradata, Broadvision, Salesforce.com, and Kana provide CRM
suites. However, these applications mostly cater to large enterprises and
B2B applications. Largest consulting firms (McKinsey, Bain [corporate
strategy]; Peppers & Rogers, Vectia [CRM strategy]; Accenture [organiza-
tional design]; Unisys, Siemens [infrastructure and systems integration])
are specialized and tend to handle the installations of these solutions,
which tend to be very costly. Some vendors such as IBM, Oracle, and
Sun enable build-it-yourself solutions. Others (e.g., EDS, CSC, Acxiom)
specialize in infrastructure and business process outsourcing. However,
despite their claim to be “complete CRM solution providers,” few soft-
ware vendors can provide the full range of functionality that a complete
CRM business strategy requires.41 Consultants and smaller vendors tend
to serve small firms and B2C application needs.
Jul 2019.
Point to Ponder: Do you think the state of B2B or B2C CRM is more
advanced? Why?
First issue of the Reader’s Digest, February 1922. The Trusted

Media Brands’ subscriber database will still be the key to long-term
success of the company.
Source: Wikimedia.
Case-in-Point: Trusted Media Brands or Reader’s

Digest Association
Trusted Media Brands, formerly known as Reader’s Digest Association

(RDA), first launched in 1922, has been successfully using direct mail
to establish relationships with its domestic and international audiences
Jul 2019.
for almost a century. Over time, its magazine subscriber database has
become a valuable asset for the company. When the company segmented
its subscribers by level of usage, it found that, the more products a cus-
tomer has bought, the higher is the likelihood of further purchases. In
this case, the length and breadth of the relationship predicted future sales
much better than traditional sociodemographic segmentation variables.
Today, Trusted Media Brands, Inc. (TMBI) has offices in 42 countries and
sells books, magazines, music, video, and educational products to a cus-
tomer database of more than 140 million in 76 countries through direct
marketing. It publishes 75 magazines (nine with more than a million
circulations), including 49 editions of Reader’s Digest, the world’s larg-
est paid-circulation magazine, and sells approximately 30 million books,
music, and video products across the world each year. It also owns the
largest food web site in the world, Allrecipes.com, which has launched 15
web sites serving 20 countries. However, direct marketing was not enough
to save a highly leveraged RDA in a post-Internet world where print media
readership including that for magazines has been steadily declining. The
company filed for bankruptcy during the global recession of 2009 but
reemerged in February 2010. It is trying to reduce its debt substantially.42
Point to Ponder: How do you think TMBI should make the tran-
sition from direct marketing to CRM? What steps should the new
management take?
Orlando Magic uses a CRM system to leapfrog NBA marketing.

Source: Wikimedia by Jeff Kern.
Jul 2019.
Case-in-Point: Orlando Magic and the Statistical

Analysis System
SAS (Statistical Analysis System) is a software system developed by the
SAS Institute for advanced analytics, multivariate analyses, business intel-
ligence, and predictive analyses. The program provides solutions to the
most critical challenges that marketers face today. It can mine, alter, man-
age, and retrieve data and conduct statistical analysis on it. Built on a
comprehensive marketing technology platform, SAS helps firms enhance
contextual customer communications based on insights derived from big
data and analytics. Furthermore, it enables firms to evaluate and optimize
the customer experience in the digital and physical worlds.43
SAS for sports helps teams find out how to vigorously engage with
fans on league and team sites and social media channels. SAS for sports
provides customer intelligence solutions that enable the teams to under-
stand fans’ needs, preferences, and behaviors and retain and increase
revenue from season-ticket holders and new fans. With SAS, the teams
can also develop the fan experience and support high-value fans with
more personalized and relevant communications, interactions, and
promotions.44
Professional sports teams in smaller markets often struggle to build a
big enough revenue base to compete against their larger market rivals. By
using an SAS CRM system, the Orlando Magic has become one of the
top revenue earners in the NBA. To increase revenue, what Magic needed
was to better understand what fans wanted. The team decided to use SAS
Analytics to facilitate predictive modeling, segmentation, and real-time
decision making in order to make sure that fans receive the best value.45
The team has achieved great success by working on the resale ticket mar-
ket to price tickets more effectively, forecast season ticket holders at risk
of defection, and examine concession and product merchandise sales.
These activities help the organization understand and offer what the fans
want every time they enter the arena. Alex Martins, CEO of the Orlando
Magic, claims that SAS helps them customize the fan’s experience in a
robust way, which is one their biggest challenges. Since Martins’ leader-
ship, the season-ticket sales have grown as large as 14,200, and the corpo-
rate sales department has achieved remarkable growth. Martins explains
how SAS adds value to the Orlando Magic:46
Jul 2019.
We adopted an analytics approach years ago, and we’re seeing it

transform our entire organization. … Analytics helps us under-
stand customers better, helps in business planning (ticket p
ricing,
etc.), and provides game-to-game and year-to-year data on
demand by game and even by seat. … And analytics has helped
transform the game. GMs and analytics teams look at every aspect
of the game, including movements of players on the court, to
transform data to predict defense against certain teams. We can
now ask ourselves, ‘What are the most efficient lineups in a game?
Which team can produce more points vs. another lineup? Which
team is better defensively than another?’ … We used to produce a
series of reports manually, but now we can do it with five clicks of
a mouse (instead of five hours overnight in anticipation of tomor-
row’s game). We can have dozens of reports available to staff in
minutes. Analytics has made us smarter.
Anthony Perez, Vice President of Business Strategy, highlights the

importance of SAS in their achievements:47
SAS has helped us grow our business. It is probably one of the

greatest investments that we’ve made as an organization over the
last half-dozen years because we can point to top-line revenue
growth that SAS has helped us create through the specific mes-
saging that we’re able to direct to each one of our client groups.
Key Takeaways
• Loyal customers are not necessarily profitable customers.
There is a need to segment the customers according to their
profit potential.
• CRM is a comprehensive strategy and process of acquiring,
retaining, and partnering with selective customers to create
superior value for the company and the customer.
• CRM has numerous benefits: it enables the marketer to
measure and manage to optimize the cost to serve customers;
profitability metrics can be tracked at the individual level;
it empowers the firm to determine which customers are not
Jul 2019.
profitable and “outsource” them, if necessary; it allows for

fine-tuning of marketing campaigns at relatively low cost
through experiments; it enables the measurement of ROMI;
finally, CRM improves customer retention as well as customer
acquisition and becomes more effective with more data over
time.
• As much of our efforts are directed at generating differenti-
ation through products or services that are not easily imita-
ble, marketing inherently strives for imperfect competition.
Relationship marketing in general and CRM via the use of
CLV metrics in particular provide competitive advantage to
firms that use them.
• The technical aspects of CRM implementation, although
expensive, are relatively easy to handle. It is the human aspects
of the CRM transformation that is challenging and time
consuming.
• (a) The costs of serving long-life customers are not necessarily
less, (b) they do not necessarily pay higher price premiums,
and (c) they do not necessarily spend more. All of the above
need to be qualified through the use of CRM.
• RFM, SOW, and PCV are traditionally used metrics to mea-
sure customer value. CLV has been claimed to be a superior
metric because it considers the future value of a customer to
the firm. CLV models range from basic to very complex.
• Strategies based on the use of CLV metric enable firms to
measure the economic value of every customer and maximize
their profits.
Jul 2019.

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BEP386

Customer Relationship Management

From Relationship Marketing Re-Imagined:

By Naresh K. Malhotra, Can Uslay, and Ahmet Bayraktar

Copyright © Business Expert Press, LLC, 2016. All rights reserved.

Are Loyal Customers Profitable Customers?

Even attitudinal loyalty may not necessarily reflect in profitability.

Effective CRM Strategy and Measurement

aspects of the CRM transformation that is challenging and time consum-

• CRM enables the marketer to measure and manage to opti-

In order to serve the customers effectively, it is important to recognize

Point to Ponder: Consider the following definition of CRM from The

Customer Relationship Management (CRM): The process of

sales calls, customer-service centers and actual purchases, sup-

What do you think of this definition?

Historical Development of CRM

it was about populating a data warehouse or undertaking data

To add to the confusion, at least a dozen definitions of CRM have

Point to Ponder: What is the difference between brand management

Measuring and Managing Customer Value

Point to Ponder: Are there cases where it is possible to conduct SOW

Past Customer Value

where i is the customer, d is the applicable discount rate, T is the number

GC = 50% × spending amount

PCV Score = $30 × (1 + 0.01) + $50 × (1 + 0.01)2 + 55 × (1 + 0.01)3

Comparing the Traditional Measures to CLV

in B2C or antitrust concerns in business-to-business (B2B) c­ontexts.

Point to Ponder: Can you provide a ranking of the effectiveness of the

Segment-Wise Calculation of CLV

In the simplest sense, if we assign (assume) a value to the revenue gener-

T is the time horizon for the calculations

Let’s consider the case of a subscription magazine targeting college

the above formula, estimated lifetime value (LTV) of a subscriber would

In this scenario, the LTV per subscriber of the magazine is signifi-

Table 7.1 The margin multiple

Instead of an infinite life, the expected lifetime of the customer

Advanced Measurement of CLV

CE(t) is the customer equity value for customer acquired at time t

Bi,r,t is the marketing in time period t for retained customers for

The average CLV can then be calculated by dividing CE by the total

Point to Ponder: The Thomas family, an older empty nest couple,

Individual CLV Calculation

Future Contribution Margin it − Future Cost it

i is the customer index,

In contrast with contractual setting where prediction of the customer

AMGCit is the average gross contribution margin in period t based on

As an example, let’s use the example of a customer who spends $60,

AMGC = (60 + 100 + 110 + 190 + 210)/5 = $134

n is the number of purchases made during the observation period

For example, consider the following purchase schedule by three cus-

Table 7.2 Purchase frequency of three customers

On the basis of previous purchase frequency patterns of Ali and Ben,

Assumptions of the model include that when a customer defects, he

CLVi is the LTV of customer i

Rust, Zeithaml, and Lemon CLV Model

Uijk = b0k LASTijk + Xik b1k + ε ijk

b0k is the logit regression coefficient for inertia

The individual choice probability for customer i is modeled as

Pijk* = Pr (customer i chooses brand k*, given that brand j

Tij is the number of purchases customer i is expected to make before

Table 7.3 Models of customer retention

Models of Representation Remarks

Markov’s t V′ is the vector of CLV,

PCV Score = $30 × (1 + 0.01) + $50 × (1 + 0.01)2 + 55 × (1 + 0.01)3

in B2C or antitrust concerns in business-to-business (B2B) contexts.

Pijk* = Pr (customer i chooses brand k*, given that brand j