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Chapter 3
Marketing Principle #2
All Customers Change Managing
Customer Dynamics
Introduction
Takeaways
Case
Another underlying issue facing managers that make marketing decisions difficult
is that all customers change
Customer’s desires/needs for most products and services change over time or due
to specific events
Individual consumer needs change (age, experience, and due to trigger events)
Customers are embedded in industries/markets, which change overtime (PCs
20 years ago and now)
Customer dynamics are changes in customer preferences that occur over time
Car at 20 _______________
Top two reasons bought __________ & ____________
Car at 30 _______________
Top two reasons bought __________ & ____________
Trigger for change _______________
Typical lifecycle
Learning effects
Product lifecycle
Constantly changing
environmental context
Product learning effects Medium Customers might learn, after using a product for a time, that
there are certain specialized or high-tech features they would
like.
Product market level
Product lifecycle Medium During early stages, consumers may purchase more new
features, in later periods, they may get more price sensitive.
Environmental level
Changes in economy, Slow to As the culture around “health food” changes, consumer
government, industry, or immediate preferences in response to dietary concerns (e.g., calories,
culture sodium, carbohydrates, gluten, fat) also change.
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© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236.
Example: General Motors
Introduction
Takeaways
Case
Simplicity Assumes all customers Combines lifecycle and Segments are not Provides insights for Requires insight into
follow one curve segmentation methods perfectly homogeneous AER decisions future migration
Ease of use Matches strategic Puts continuous change Supports a customer- Requires detailed
Averages all customers
marketing thinking into discrete stages centric culture financial data
Ignores causes of Identifies temporally Captures dynamics and
customer dynamics homogeneous groups heterogeneity
Pros:
Easy to apply
Makes common sense
Cons:
Misses many unique trigger points and migration paths (ignores
temporal heterogeneity)
Inaccurate and/or ineffective for many firms
5. The decline stage, when sales decay for the industry as a whole
Descriptions
of the Stages
• Product just launched on the • Product gains acceptance in • Product is widely accepted, • Destructive competition
market, often perceived as the market, and sales and growth begins to slow, and changing consumer
risky by customers. expand quickly. because fewer new users needs and desires lead to
are available. product decline.
• Most relevant features are still • Users are more comfortable
unknown by customers and with the product and know • Market becomes • Firms’ sales and profits
sellers. which features they want. competitive, and some decline.
firms drop out.
• High prices. • More focus on retaining • Firms with higher cost and
customers and generating • Intense price competition those without a unique
• Seller focuses on finding new
repeat sales. reduces profits. advantage exit the market.
customers and promoting
product trials. • Customers become • Some sellers focus on niche • Market often consolidates
increasingly price sensitive. segments to avoid with fewer suppliers.
© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236.
competitive pressures.
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14
Customer Dynamic Segmentation Approach
Prospective A1 E1 R1
Customers
A2
E2 R2
Lost
Customers
© Palmatier, 2017,
Marketing Strategy, (See Data Analytic Technique 3.1 for more details of HMM) 17
17
Palgrave. ISBN: 9781137526236.
DAT 3.1 Hidden Markov Model (HMM) Analysis
How It Works
• A customer’s relationship with a firm exists in one of several possible unobserved (or hidden) stage, each with finite probability. Customer behavior
varies depending on the stage, such that a “stronger” stage customer likely buys more than one in a “weak” stage. In HMM, customers also have a finite
probability of transitioning from any one stage to another, partially as a function of marketing efforts. For example, advertising might cause customers
to shift from a weaker to a stronger stage.
• Customer behaviors (e.g., purchases) and firm actions (e.g., marketing) serve as inputs to the HMM, which estimates five outputs: (1) the number of
feasible states (or dynamic stages) in the data; (2) initial probability that a customer is in each state; (3) transition probabilities, or the probability that
customers move from one state to another; (4) the conditional probability of a behavior, given the customers’ hidden state; and (5) the effect of
marketing in moving customers across stages.
Example
To dynamically segment alumni donation behavior and investigate which of its marketing activities prompt donors to give money, ABC University
conducted a HMM analysis that identified three hidden states: dormant (corresponds with no donation), occasional (corresponds with infrequent
donation), and active (corresponds with frequent donation). With low marketing effort, dormant customers remain dormant in the next period with a
90% probability (red text); active customers have a 33% chance of becoming occasional in the next period (green text). With high marketing effort
though, the dormant customers become occasional donors with a 57% probability (red text), and active customers exhibit only a 25% chance of
becoming occasional (green text), both of which are good for ABC.
Endowment
Migration 62% 16% 21%
Transitional State
(29%)
Exploration Weak
Migration 35% 7% Neglect Relationships
Migration
Transactional
State (50%)
Recovery
38% 13% Betrayal
Migration
Migration
Damaged State
(57%) Poor
Relationships
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© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236.
Insights for B2B Hidden Markov Model
Example
States in HMM describe different types of behavior that the same (or different)
consumers might exhibit at different points of time; transitions among states
capture the notion that consumers can switch from one state to another at any
point in time
In the transactional state, the relationships indicate low levels of customer
trust, commitment, dependence, and relational norms
If customers follow a positive migration path and move to the transitional
state, they do so only briefly
In the communal state, the levels of trust, commitment, dependence, and
relational norms are higher than in any other state, and the relationship
produces good cooperation and profit
The damaged state produces low levels of trust and commitment and very low
relational norms and cooperation, though customer dependence tends to stay
high
75% of the marketers are engaged in some level of CLV effort within the
organization
Number of
Customers
Modestly Modestly
Unprofitable Profitable
Heavy Highly
Losses Profitable
Breakeven
But, some customers are more costly to acquire or retain (lowering prices, high
service levels)
(1 d )t
Where
CFi,t = net cash flow generated by the customer i at time t
T = time horizon for estimating the CLV
d = discount rate
Assuming that T infinity and that the contribution margin and marketing costs
(weak) do not vary over time
Assuming that the contribution margin and marketing costs do not vary over
time, the CLV in dollars for the ith customer reduces to just five inputs:
1. Mi = margin for ith customer in $ (sales $ and margin as %)
2. Ci = annual marketing cost for ith customer in $
3. ri = retention rate for ith customer as a %
4. d = discount rate as a %
5. Ai = acquisition cost for ith customer in $
How it Works
Customer lifetime value is the dollar value of a customer relationship, according to both its present value and the projected future cash flows from the
relationship. The calculation process consists of three steps: (1) estimating the remaining customer lifetime, or number of years over which a customer is
likely to maintain a relationship with the firm, normally according to retention rates; (2) forecasting net profits from the customer over the predicted
lifetime, and (3) calculating the net present value of the future amounts. Because CLV ranks customers on the basis of profitability, it can target marketing
campaigns toward the most high value customers. The CLV formula is given as follows.
where:
𝐶𝐿𝑉𝑖 = Customer Lifetime Value
Mi = margin for ith customer in $
𝑀𝑖 −𝐶𝑖
𝐶𝐿𝑉𝑖 = − 𝐴i Ci = annual marketing cost for ith customer in $
1−𝑟𝑖 +𝑑
ri = retention rate for ith customer as a %
d = discount rate as a %
Ai = acquisition cost for ith customer in $
Both current and potential customers can be segmented according to expected long-term profits or CLV. The graph below plots the CLV distribution of firm,
which consists of inactive customers (low to negative CLV), active customers (positive CLV), and highly active customers (very high CLV) shows that the
right portion of the graph below highlight a firm’s most active customers). Firms can use such a graph to identify and target the most profitable customers
for marketing retention campaigns.
Customers
Customers
CLV
Example
A manager of a cable company wants to determine if it is strategic to acquire the Brett family, by estimating their household-level CLV. The manager
estimates that it will cost the company $65 (A) to get the Bretts’ to switch, and the Bretts’ will generate $100 profit each year (M), with a $10 annual
marketing cost to retain them (C). The estimated retention rate (r) is 65%, and the current discount rate is 5%.(d) . From the formula, the CLV for the
Brett’s is $235, which suggests the Brett’s on net, are profitable to the cable company.
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Example: RBC (Canada)
In the first year, RBC’s market share in this segment increased from 2% to
18% and average sales were four times higher than average customers..
These customers were also very loyal.
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© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236.
Some Generalizations on AER Strategies
from CLV Analysis
AER strategy that maximizes CLV maximizes neither the acquisition rate
nor retention rate
(Kumar 2005)
© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236. 29
Customer Referral Value (CRV)
Direct marketers have been using a simplified version of the CLV for
decades, targeting customers to receive expensive catalog mailings. They
use three readily available customer behaviors:
Recency or time elapsed since last purchase
Frequency of purchases in last period
Monetary purchases in last period
Using the profits generated from a test mailing to a few customers from
each group, direct marketers then mail the catalog only to the groups
with an acceptable return on investment
R
5 F
35 M
4 335
34
334
3 33 333
332
32
2 331
31
Twenty-five
1 sorts
Five
Database Sorts
One Sort
RFM Cell
© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236. 33
Lost Customer Analysis Informs AER
Strategies
A firm contacts customers that have migrated away, to identify the cause for this change,
then works backward to fix the problem and ensure other customers don’t leave for the
same reason
Takes a significant number of lost customers before a firm recognizes that it isn’t just
“normal” customer churn but rather an indication of an underlying problem
Three-step process, which provides insights into both strengths and weaknesses:
1. Firms set regular intervals for contacting lost customers to identify the cause of their transition,
where they went, and potential recovery strategies
2. If the lost customer is not in the firm’s main target segment, firms could:
a. Change their acquisition criteria
b. Evaluate an expansion strategy to address a new subsegment of customers
3. If the lost customer is in the firm’s target market, firms should:
a. Fix the problem
b. Implement retention strategies to build brand and relational loyalty
A choice model can benefit the lost customer analysis, and can inform analyses across all
AER stages, because it predicts the likelihood of observed customer choices/responses,
using data about that customer’s characteristics and past behaviors, as well as the firm’s
marketing interventions
© Palmatier, 2017, Marketing Strategy, Palgrave. ISBN: 9781137526236. 34
What are Choice Models?
High
Marginal Impact
of a Marketing
Action
Low
0.0 0.5 1.0
Probability of Choosing an Alternative
Assumes that consumers make rational choices based on their individual utility
with a diminishing sensitivity for marketing effort
Thus, marketing has the highest effect on people who are “sitting on the fence”
(i.e., probability of .5 of choosing an alternative)
Intensity of
Observations / Choice Choice contact with Distance to Coworkers in
Income level
data (0/1) EMBA (internet, campus the program
mailing, call, visit)
1 1 3 7 1 7
2 0 6 4 7 3
3 0 6 4 7 7
4 1 7 7 1 7
5 1 2 7 1 7
6 0 5 6 6 3
7 0 3 1 6 3
Coefficient Estimates
Elasticities
Variables / Coefficient Coefficient Standard
t-statistic Elasticities of Income
estimates estimates deviation Response Dummy
level
Income level 1.700397 1.172524 1.450202 Response 0.245253 -0.38359
Intensity of contact with Dummy 0 0
EMBA (internet, 23.18698 50.94818 0.455109
mailing, call, visit)
Elasticities of Intensity
Distance to campus -1.0191 0.508133 -2.00548
of contact with EMBA
Coworkers in the Response Dummy
2.092535 1.125706 1.858866 (internet, mailing, call,
program visit)
Const-1 -151.835 307.1951 -0.49426
Baseline n/a n/a Response 5.474283 -8.5622
Dummy 0 0
Probabilities
Elasticities of Distance
Response Dummy
to campus
Respondents / Choice Response Dummy Predicted Predicted Observed Observed Response -0.25866 0.404571
probabilities probability probability Response Dummy Response Dummy Dummy 0 0
How it Works
• In a choice model setting, every individual is assumed to derive an unobserved product-specific utility from several product options. The individual is
assumed to pick the product option that provides the maximum utility. The dependent variable in a choice model is binary: every individual chooses (or
does not choose) a product option.
• Every product option’s attractiveness is assumed to stem from a finite set of attributes (e.g., brand name, price, advertising). The independent variables in a
choice model are the measure of the strength of attributes of each of the product option, e.g., product option 1 may have a low price, while product option 2
may have a higher price.
• The model uses the two inputs (dependent variable, independent variables) to estimate several outputs. First, it provides the weights (or coefficients) that
each attribute would have had to cause customers to pick a certain product. This provides the most important factors that influence customer choice
likelihood.
• Second, it is used in a predictive sense. For example, when we only observe product attributes, we can use the attributes and the weighs of the model to
predict the choices that are likely to be made by a new set of customers. This in turn can help a firm segment and target customers based on choice
likelihood.
• Third, the model can be used to simulate the market share of a product category, by adding up the product choices made by all customers faced with all
products. This can help manages plan their marketing efforts.
Example
A retailer is planning to introduce a store brand of bleach (Store Brand “C”) in their bleach category, which predominantly has two national brands
(Brand “A” and Brand “B”). The manager responsible for the store brand obtains transaction data from all the retail stores on the sales, price and
promotional efforts by Brand A and Brand B. With a choice model, the manager learns the weights and elasticities associated with price and
promotional efforts respectively. A 1% increase in the price of Brand A decreases the sales of Brand A by 2.7%, while it increases the sales of Brand B by
1.6%. A 1% increase in the price of Brand B decreases the sales of Brand B by 3.7%, while it increases the sales of Brand A by 1.2%. A 1% increase in
promotional intensity (a 10% price cut for 2 weeks) by Brands A and B increases their respective sales by 8% and 6% respectively. The model fits the
data very well, and hence the retail manager feel confident about the results. Also, the manager learns that frequent price promotions, and lower price
do help increase market share significantly. Hence, the retail manager decides to introduce the store brand (Brand C) as a low price, generic version of
bleach (price 20% below Brands A and B), with promotions held 20% more frequently than Brands A and B. The goal of the store brand introduction is
to steal market share from Brands A and B, especially in a category where price seems to have a large effect on sales (as learnt from a choice model).
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Agenda
Introduction
Takeaways
Case
Introduction
Takeaways
Case
Path B Path C
One Timers
Upgraded Bored
Customers Customers
Lost
Customers
Path D
Followers
segment
Sales
Early
adopters segment
Innovators segment
© Palmatier, 2017,
Marketing Strategy, Palgrave. ISBN: 9781137526236. Time
4848
Agenda
Introduction
Takeaways
Case
The second underlying challenge that firms face when making marketing
decisions is that all customers change. This principle can be either an
opportunity or a threat, depending on how well the firm understands and
manages it.
The framework for managing customer dynamics uses three inputs: CRM,
marketing programs, and lost customer data. It produces three outputs:
dynamic segmentation and AER positioning statements and strategies.
Introduction
Takeaways
Case
Problem: market share and annual sales down, increasing customer churn
rates, drop in ratings of warranty, sales support, and delivery speed
Need to manage customer dynamics (What product attributes are desired? How to
segment the market? Which customers to acquire and expand?)
Data:
Acquisition model: 1000 acquired and 1000 non-acquired customers
Expansion model: 1000 retained and 1000 non-retained customers
Drivers of acquisition/retention: price, warranty, delivery time, sales support,
industry group, firm size, centralized buying center