Customer lifetime value: stochastic optimization approach

Abstract

Since the early 1980s, the concept of relationship marketing has been becoming important in general marketing, especially in the area of direct and interactive marketing. The core of relationship marketing is the maintenance of long-term relationships with the customers. However, the relationship marketing is costly and therefore, the determination of the customer lifetime value (CLV) is an important element in making strategic decisions in both advertising and promotion. In this paper, we propose a stochastic dynamic programming model with a Markov chain for the optimization of CLV. Both cases of infinite horizon and finite horizon are discussed. The model is then applied to practical data of a computer service company.

Keywords:

• customer lifetime value
• relationship marketing
• stochastic dynamic programming
• Markov process

Acknowledgements

Research supported in part by RGC Grant Nos HKU 7126/02P, HKU 7130/02P, HKU 7046/03P, and HKU CRCG Grant Nos 10203408, 10203501, 10203907, 10205105, 10204436.