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Balancing Acquisition and Retention Spending for Firms with Limited Capacity

Author

Listed:
  • Anton Ovchinnikov

    () (Darden Graduate School of Business, University of Virginia, Charlottesville, Virginia 22903)

  • Béatrice Boulu-Reshef

    () (Darden Graduate School of Business and Department of Economics, University of Virginia, Charlottesville, Virginia 22903)

  • Phillip E. Pfeifer

    () (Darden Graduate School of Business, University of Virginia, Charlottesville, Virginia 22903)

Abstract

This paper discusses the interaction between revenue management and customer relationship management for a firm that operates in a customer retention situation but faces limited capacity. We present a dynamic programming model for how the firm balances investments in customer acquisition and retention, as well as retention across multiple customer types. We characterize the optimal policy and discuss how the policy changes depending on capacity limitations. We then contrast the modeling results with those of a behavioral experiment in which subjects acted as managers making acquisition and retention decisions. In the modeling part of the paper, we introduce a concept of the value of an incremental customer (VIC), and show that when capacity is unlimited, VIC equals customer lifetime value (CLV), but when capacity is limited, VIC is much smaller and changes dynamically depending on the number of customers and their mix. As a result, the optimal spending is constant and depends on CLV for the firms with unlimited capacity, but changes dynamically and is generally unrelated to CLV when capacity is limited. In the experimental part, we introduce a concept of conditional optimality for the analysis of state-dependent decisions. Applying this concept to our data, we document a number of decision biases, specifically the subjects' tendency to overspend on retaining high-value customers and underspend on lower-value customers retention and acquisition. We show that providing CLV information exacerbates these biases and leads to a loss of net revenue when capacity is limited, but providing information about the marginal costs of acquisition and retention eliminated these biases and increases net revenue.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1842 . This paper was accepted by Yossi Aviv, operations management.

Suggested Citation

  • Anton Ovchinnikov & Béatrice Boulu-Reshef & Phillip E. Pfeifer, 2014. "Balancing Acquisition and Retention Spending for Firms with Limited Capacity," Management Science, INFORMS, vol. 60(8), pages 2002-2019, August.
  • Handle: RePEc:inm:ormnsc:v:60:y:2014:i:8:p:2002-2019
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    File URL: http://dx.doi.org/10.1287/mnsc.2013.1842
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    References listed on IDEAS

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    1. Goker Aydin & Serhan Ziya, 2009. "Technical Note---Personalized Dynamic Pricing of Limited Inventories," Operations Research, INFORMS, vol. 57(6), pages 1523-1531, December.
    2. Sunil Gupta & Valarie Zeithaml, 2006. "Customer Metrics and Their Impact on Financial Performance," Marketing Science, INFORMS, vol. 25(6), pages 718-739, 11-12.
    3. Francis de Véricourt & Miguel Sousa Lobo, 2009. "Resource and Revenue Management in Nonprofit Operations," Operations Research, INFORMS, vol. 57(5), pages 1114-1128, October.
    4. Sam Aflaki & Ioana Popescu, 2014. "Managing Retention in Service Relationships," Management Science, INFORMS, vol. 60(2), pages 415-433, February.
    5. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
    6. James E. Smith & Kevin F. McCardle, 2002. "Structural Properties of Stochastic Dynamic Programs," Operations Research, INFORMS, vol. 50(5), pages 796-809, October.
    7. Michael Lewis, 2005. "Research Note: A Dynamic Programming Approach to Customer Relationship Pricing," Management Science, INFORMS, vol. 51(6), pages 986-994, June.
    8. Roland T. Rust & Tuck Siong Chung, 2006. "Marketing Models of Service and Relationships," Marketing Science, INFORMS, vol. 25(6), pages 560-580, 11-12.
    9. repec:wly:navres:v:55:y:2008:i:1:p:59-75 is not listed on IDEAS
    10. Mak, Vincent & Rapoport, Amnon & Gisches, Eyran J., 2012. "Competitive dynamic pricing with alternating offers: Theory and experiment," Games and Economic Behavior, Elsevier, vol. 75(1), pages 250-264.
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    Cited by:

    1. Ascarza, & Neslin, & Netzer, & Lemmens, Aurélie & Anderson, Zachery & Fader, Peter S. & Gupta, S. & Hardie, B.G.S. & Libai, Barak & Neal, David & Provost, Foster, 2018. "In pursuit of enhanced customer retention management : Review, key issues, and future directions," Other publications TiSEM 28a90d28-6daf-42f1-bd8e-e, Tilburg University, School of Economics and Management.
    2. repec:eee:oprepe:v:5:y:2018:i:c:p:45-58 is not listed on IDEAS
    3. repec:spr:custns:v:5:y:2018:i:1:d:10.1007_s40547-017-0080-0 is not listed on IDEAS

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