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ABSTRACT
As marketing activities become more precisely targeted to
consumers through direct and interactive forms of communication,
customer profitability takes on a central role in the development of
marketing strategies. This paper provides a conceptual and
methodological foundation for measuring customer profitability by
generalizing approaches to measuring customer lifetime value in
direct marketing for broader target marketing applications. Particular
emphasis is placed on the precise specification of the inputs into a
profitability analysis and the measures of the degree of
concentration of profits among customers. An empirical analysis
involving the profitability of customers in a business-to-business
marketing context is described, along with research propositions for
future work on the determinants of customer profitability.
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JOURNAL OF INTERACTIVE MARKETING
26
CUSTOMER PROFITABILITY ANALYSIS
quent assessment of the distribution and deter- specification of a profitability analysis should be
minants of profitability, will become central to made in the context of the strategic situation,
the data-driven world of interactive marketing. and will vary for different applications. For ex-
In the traditional marketing literature, few ample, a profitability analysis done for the pur-
studies have provided sophisticated analysis of pose of allocating a sales force might use cor-
customer profitability. Berger and Nasr (1998) porate customer locations as the customer unit,
provide an excellent treatment of the structural whereas an analysis for direct marketing might
modeling aspects for constructing profitability use individuals as the customer unit. Below we
models. This treatment goes well beyond the identify the key measurement components and
more heuristic structural models provided in the issues involved in specifying a profitability
the direct marketing literature (Dwyer, 1989; measure.
Keane and Wang, 1995). Storbacka (1998) de-
scribes customer profitability as a central aspect Profitability Measurement Components
in relationship marketing, and provides some
measures for evaluating the distribution of prof- Specification of Customers. Definition of Cus-
itability across customers. Papers by Schmit- tomer Unit. The customer unit is the entity for
tlein, Morrison, and Colombo (1987) and which profitability is computed. Firms often dis-
Schmittlein and Peterson (1987) provide sto- tinguish different types of customers (e.g., con-
chastic modeling procedures for determining sumer versus corporate customers for an air-
two of the micro-level inputs to a profitability line, store versus catalog shoppers for a
analysis—whether a customer is still “active,” retailer). Depending on the application, a prof-
and what future purchase behavior can be ex- itability analysis could be performed for all cus-
pected. While these studies provide important tomers, or some specified customer unit. Spec-
elements for customer profitability, there is no ification of the customer unit delineates the
systematic treatment in the literature of the scope of a profitability analysis.
measurement issues involved in customer prof-
itability. The purpose of this paper is to formally Aggregation of Customer Units. Ideally, a profit-
set forth the issues that are involved in (1) ability analysis is performed for the individual
measuring customer profitability and (2) evalu- customer units; however, in some cases it is
ating the concentration of profitability among preferable to compute profitability at a higher
customers. We go on to discuss how customer level of aggregation. Higher levels of aggrega-
profitability measures can be used for strategic tion are practical when individual customer
marketing practice and what research is needed purchase data are not available or individual-
to develop customer profitability as a useful level marketing is not feasible. For example,
research area. To help demonstrate the impli- consumer packaged goods manufacturers
cations of the measurement issues raised here, might not find it economically practical to mar-
we provide an empirical analysis in a business- ket to individual customers because of the low
to-business marketing context. dollar amount of individual purchases. A higher
level of aggregation could represent a market
segment consisting of customers that should
MEASURING CUSTOMER PROFITABILITY receive the same communication.
While measuring customer profitability might In consumer marketing, individual custom-
appear to be a straightforward process, it is ers are often studied at the household level. In
actually quite complex. The exact specification business marketing, the customer unit issue is
of a profitability analysis has important implica- more complex. Customer units can be defined
tions for marketing decisions based on profit- in many different ways: an entire corporation
ability measures. Accordingly, it is crucial to with several holdings, strategic business units
consider the many specification issues that per- (SBUs), divisions of SBUs, departments within
tain to a profitability analysis. The appropriate divisions, or specific corporate locations. What-
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JOURNAL OF INTERACTIVE MARKETING
ever the chosen unit of analysis, consideration versely, profitability analysis can be performed
must be given to the comparability of the cus- at an aggregate level such that every element of
tomers. Profitability results can be distorted the relationship between an organization and a
when there are major size differences in cus- customer is included in a single profitability
tomer units. measure. From a relationship marketing per-
spective, all of the brands or products pur-
Existing or Prospective Customers. A profitability chased should be included. In practice, how-
model may be constructed for both existing ever, lesser levels of aggregation may be
customers and prospective customers. While appropriate for certain marketing decisions.
measures of profit for both customers and pros-
pects are important, it is much easier to build Organizational Level.
models for existing customers because detailed Depending on data availability, profitability
information on their purchases is often avail- analysis can be performed at a variety of orga-
able in marketing databases. Information on nizational levels. For example, a computer soft-
prospects can be extremely difficult to obtain. ware company could compute the profitability
The potential profit of prospects can be mea- of customers at the level of its own sales territo-
sured by matching them to existing customers ries, local sales offices, regional sales offices, or
with data mining and clustering techniques that the national level.
identify similarities among observations.
Customer Profitability Measure Core Profit El-
Determining Which Customers Are “Active.” Cus- ement. A profitability model centers on a core
tomers in a database vary dramatically in their profit component, typically dollar contribution.
purchase activity. Most customer databases con- Other measures could be used, depending on
tains names of customers who are no longer the purpose of the analysis. For example, cus-
active. Should a customer who made extensive tomers who are opinion leaders or market ma-
purchases a year ago, but has made no pur- vens, avid proponents of a product or brand to
chases in the current year be included? The others (Feick and Price, 1987), may be valued at
determination of what qualifies a customer as a level above what is represented by their own
active is critical because the profit of each cus- profit contribution.
tomer is assessed relative to the profit of other
customers. The question of delineating the sta- Present or Future Profit.
tus of customer has been addressed in detail by Customers can be evaluated based on present
Schmittlein et al. (1987) and Schmittlein and purchase behavior or of the anticipated future
Peterson (1994). Those papers compute the stream of purchases. One aspect of customer
probability that a customer is active given the lifetime value models that is not often discussed
number and timing of purchase transactions. is the need to forecast individual customer pur-
Such an analysis is an important precursor to chase behavior over the specified lifetime. This
profitability measurement. Schmittlein et al. can be performed with well-established forecast-
(1993) show that the evaluation of the concen- ing techniques (e.g., exponential smoothing or
tration of purchases among customers can be ARIMA models), or by using an analog ap-
dramatically affected by whether nonusers are proach where customer purchases are pre-
included in an analysis. dicted by evaluating the purchase behavior of
similar customers in the past. However, models
Specification of Products/Services Level of incorporating predicted future purchases are
Products/Services. Separate profitability analysis subject to a great deal of forecasting error.
can be performed for individual product lines The appropriateness of future-oriented life-
or brands. For example, a computer manufac- time profitability analysis varies by industry.
turer could do separate analyses for main- Lifetime analysis is natural for industries such as
frames, workstations, and desktop systems. Con- financial services and some business-to-business
28
CUSTOMER PROFITABILITY ANALYSIS
supplier relationships in which customers natu- lifetime models). Schmittlein, Cooper, and
rally are bound to an organization for a long Morrison (1993) show that the length of the
time period because of high switching costs. time affects the measured concentration of pur-
However, in many industries, customer lifetimes chases among customers. Typically the length-
are difficult to specify because the length of a of-time-period decision should be made based
“relationship” maybe very short. More impor- on the time-related aspects of customer life-
tantly, the difficulty in projecting purchase be- time, interpurchase times, and an organiza-
havior at the individual level makes lifetime tion’s planning cycle.
models difficult to estimate. Hence, we advocate
profitability analysis of past purchase behavior Cost Allocations Assignment of Variable
initially, with subsequent analysis of projected Costs. A fully developed profitability model
future purchases for more sophisticated appli- features the assignment of variable costs to cus-
cations. When future purchases are included in tomers. Variable costing shifts a revenue analy-
a profitability model, dollars must be adjusted sis to a contribution margin analysis. When vari-
to present profit using a standard net present able costs cannot be allocated, less complete
profit procedure, as discussed in research on formulations can be used that assign costs to
customer lifetime value (Berger and Nasr, 1998; market segments, or collapse variable costs into
Keane and Wang, 1995). fixed costs. More sophisticated customer data-
bases contain data on the costs for marketing
Brand or Category Profit. communications and other customer-specific
Models can be constructed to measure the variable costs. In fact, the mere matching of
realized profit from a customer’s purchases variable marketing costs to revenue streams of
from one company (brand), or the category customers is valuable information for market-
level profit represented by the sum of a custom- ing decisions. In most cases, fixed costs are not
er’s purchases from all companies selling in a allocated to customers (Berger and Nasr, 1998;
category. Typically, one would first measure Dwyer, 1989). Foster, Gupta, and Sjoblom
brand profit, and then attempt to estimate cat- (1996) provide a more detailed description of
egory-level profit. The most complete picture is the cost accounting issues that should be con-
obtained by measuring both brand and cate- sidered when computing customer profitability.
gory-level profit. This allows for the computa-
tion of share of requirements—the portion of a Assignment of Acquisition Costs.
customer’s profit that one company possesses. In some industries there are specific and de-
Marketing resources can then be allocated ac- finable acquisition costs, such as prospecting
cording to the available potential profit that can sales calls, product specifications, and price dis-
be obtained by attracting a larger portion of counts. More typically, acquisition costs cannot
customer category expenditures. be directly assigned to individual customers. For
example, consumer packaged goods manufac-
Length of Time Period. turers spend a great deal of money in media
For both the analysis of projected future or advertising, much of which is intended to ac-
actual past purchases, a decision must be made quire new customers. However, there is no way
regarding the length of time that a profitability to match media expenditures with the custom-
analysis should encompass. Longer time peri- ers that are attracted. Thus the only possible
ods incorporate more purchase cycles and allocation would be to apply an average cost to
therefore are less subject to behavioral anomo- all customers—a practice that simple lowers
lies. However, longer time periods involve the each customer’s computed profitability by a
diminished relevance of more historical data constant, leaving the relative profitability of
(in the case of analysis of past data) or the each customer unchanged. In such instances,
increasing inaccuracy of projected future pur- acquisition costs are best left out of a profitabil-
chases as time into the future increases (for ity analysis.
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JOURNAL OF INTERACTIVE MARKETING
A final aspect we note is the possible inclu- pijt 5 the price of purchase j made by customer
sion of customer responsiveness to marketing i in period t,
efforts. Typically, profitability models are cijt 5 the unit cost of purchase j made by cus-
“closed” in that the value of a customer is as- tomer i in period t,
sumed to exist independently of marketing ac- mcikt5 variable marketing cost, k, for customer i
tions. However, the value of a customer is partly in period t,
a function of the marketing efforts directed at r 5 the discount rate for money established
that customer. Deighton, Peppers, and Rogers to reflect the riskiness of cash flow.
(1994) note the profitability of a customer de-
pends in part on a firm’s ability to leverage its Customer lifetime models are appropriate
access to the customer. A firm can increase a when customers have ongoing relationships
customer’s actual or potential profit by improv- with organizations and future purchase and cost
ing product or service performance, changing streams can be accurately forecast at the indi-
prices or conducting effective communications. vidual level. In marketing situations where life-
Accordingly, a more advanced form of profit- time analysis is not relevant or when accurate
ability analysis would include response coeffi- projections of purchase cannot made, be a his-
cients that account for the effects of marketing torical profitability analysis can be performed.
efforts on customer profit. This is a recursive The following model applies for historical prof-
model, and is analogous to diffusion of innova- itability models:
tion models that represent the diffusion rate
and saturation levels as a function of marketing
FO SO DG
effort (Mahajan, Muller, and Bass, 1990).
O mc
T Ji Ki
O ~p O mc
Ji Ki necessarily apply to purchases in time period t.
ijt 2 c ijt! 2 ikt Since this is a simple additive model, it makes
O
T
j51 k51 no difference if net contribution margin (price
CP i 5 (1)
t51
~1 1 r! t minus cost of good sold minus variable market-
ing costs) is computed separately for each time
period, or computed singly after margin and
where
variable costs are discounted to present time
CPi 5 the profit of customer i to a firm, separately.
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CUSTOMER PROFITABILITY ANALYSIS
TABLE 1
Specification of Customer Profitability Measure for Empirical Analysis
Specification of Customers
Customer Unit Physicians
Aggregation level Individuals
Existing or Prospective Customers Existing
Active Condition All physicians writing one or more prescriptions
Specification of Products
Aggregation of products All products sold by firm
Organizational level Three sales territories
Customer Profitability Measure
Core profit element Dollar contribution
Present of Future Profit Present
Brand or Category Profit Brand (company)
Length of time period 1.5 years
Cost Allocations
Assignment of variable costs Sales calls, product samples, direct mail
Acquisition costs None
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JOURNAL OF INTERACTIVE MARKETING
FIGURE 2
Customer Profit Ordering for Physicians: Highest to Lowest
32
CUSTOMER PROFITABILITY ANALYSIS
FIGURE 3
Frequency Distribution of Customer Profit for Physicians
customer profit for the physicians in our empir- Viewing the distribution of customer profits
ical demonstration. Note that there are a few becomes cumbersome when a large number of
extremely high-profit customers (about 100 cus- customers exist. Therefore, it is useful to con-
tomers generate over $20,000 in profit each) vert the raw data into percentiles, and plot the
and a large number of very low-profit custom- cumulative percentile of customer profit against
ers. This figure clearly shows that a large por- the cumulative percentile of the number of cus-
tion of profits comes from a relatively small set tomers. (A common practice in direct market-
of customers. ing is to classify customers into 10 deciles. While
Another tool for assessing the distribution of deciles have the advantage of being easily com-
customer profit is a frequency distribution as municated to managers, percentiles allow for a
shown in Figure 3. Importantly, one should be much more precise level of analysis.) A graphi-
careful not to confuse the customer profit plots cal representation of percentiles is known as a
in Figure 2 with a frequency distribution in Lorenz curve in economics, where it is used to
Figure 3. In Figure 2, the vertical axis is repre- represent the concentration of incomes (Sen,
sents profit while the horizontal axis represents 1997). The convention in economics is to rep-
customers, in descending order of profit from resent the cumulative percentiles on the hori-
left to right. In the frequency distribution zontal axis such that the first percentile corre-
shown in Figure 3, the vertical axis represents a sponds to the lowest-income consumers while
frequency and the horizontal axis represents the highest percentile corresponds to the high-
customer profit dollar ranges. est-income consumers. We use this convention
FIGURE 4
Lorenz Curve for Customer Profit
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JOURNAL OF INTERACTIVE MARKETING
FIGURE 5
Inverted Lorenz Curve for Physicians
in Figure 4, which shows a hypothetical Lorenz negative when variable marketing costs exceed
curve. The horizontal axis represents cumula- unit contribution. Conceptually, when some of
tive percentiles of customers ordered from the the percentiles generate losses, the bow would
least to the most profitable. The straight 45- drop below the horizontal axis. However, this is
degree line represents points where the cumu- not numerically attractive because there is no
lative percentile of customers is equivalent to sensible interpretations for negative values of
the cumulative percentile of customer (e.g., the vertical axis. A suitable remedy to this prob-
40% of the customers provide 40% of the total lem is to flip the Lorenz curve above the 45-
profit). This condition is analogous to the flat degree line as advocated by Schmittlein et al.
customer profit curve in Figure 1. When cus- (1992) and Storbacka (1997). By flipping the
tomer profit is distributed unevenly across the curve above the 45-degree line, we avoid the
percentiles, the Lorenz curve bows downward. presence of the lower bound present in a tradi-
The extent of this bow represents the degree of tional Lorenz curve. The lower bound elimi-
unevenness in customer profit. The most ex- nates the possibility that a portion of the cus-
treme form of profit concentration would be if tomer base constitutes more than 100% of the
one customer represented 100% of all profits profit. Also, the inverted Lorenz curve is more
while all other customers provided zero profit. amenable for marketing purposes, since mar-
This situation can be represented by a Lorenz keters are often concerned with the highest
curve that goes along the horizontal axis until profit market segment. Also, with the inverted
the 100th percentile, at which point it goes Lorenz curve, the placement of customers
vertically up to the 45-degree line. along the horizontal axis is consistent with the
An important observation is that a sharply highest-to-lowest ordering used in Figures 1 and
descending curve for the ordering of customer 2. Flipping the curve above the axis is achieved
profit, as in Figure 2, corresponds to a skewed by reversing the percentiles on the horizontal
frequency distribution (see Figure 3) and a axis such that the first percentile represents the
highly bowed Lorenz cure (see Figure 4). most profitable one percent of customers. Fig-
A shortcoming of using the Lorenz curve for ure 5 shows the inverted Lorenz curve for the
profitability analysis is that it cannot portray physicians in our empirical analysis. Note that
percentiles of customers who represent a finan- the curve is quite bowed and surpasses the
cial loss to a firm. Customer profitability will be 100% line. The apex of the curve represents the
34
CUSTOMER PROFITABILITY ANALYSIS
portion of customers who are profitable. Each all mean or extreme values that determine
percentile to the right of the apex (represent- other disparity measure. Sen (1997) and Cowell
ing about 15% of the customers) reduces the (1977) provide comparisons of measures of dis-
overall profitability of the customer base. Profits parity used in economics. The Gini coefficient
are quite concentrated, as 20% of the customers for a Lorenz curve is defined as:
account for 65.5% of the profits and half the
customers account for 95.5% of the profits.
The disparity of customer profit evident in A
Modified GINI 5 (3)
Figure 5 can also be depicted mathematically. A1B
Many measures of disparity can be applied to
customer profitability. These include the range,
the standard deviation, the mean absolute devi- where A is the area above the 45-degree line in
ation and the coefficient of variation. Here we Figure 5 and B is the area below the 45-degree
describe two more popular measures of income line. For a standard Lorenz curve, the Gini co-
disparity that can equivalently be applied to a efficient ranges from zero (even distribution of
Lorenz curve for customer profit. For a stan- profit) to one (all profits from one customer).
dard Lorenz curve (Figure 4), the Schultz coef- For the inverted Lorenz curve, the modified
ficient is a measure of the longest vertical dis- Gini coefficient, like the Schultz coefficient, has
tance between the 45-degree line and the a minimum of zero but no upward bound. In
Lorenz curve (Cowell, 1977). The Schultz coef- our empirical example, the modified Gini coef-
ficient is represented geometrically by the line ficient is 0.666. The Schultz coefficient is 50.02.
in Figure 4. The Schultz coefficient has a min- Each of these numbers represents a very high
imum of zero and a maximum of 100, and is level of disparity in customer profit. Their inter-
measured in the units of the vertical axis (cu- pretation of these measures becomes more
mulative percent of customer profit). For the meaningful in the context of comparing mea-
inverted Lorenz curve in Figure 5, the Schultz sure of disparity of profits across firms, product,
coefficient can exceed 1.0, as there is no up- sales territories or time.
ward bound in profit concentration (since some One other measure of disparity (concentra-
consumers could theoretically contribute infi- tion) of customer purchases is proposed by
nite losses). Higher Schultz coefficients corre- Schmittlein et al. (1993). They show that if pur-
spond to greater concentration of customer chasing rates are distributed gamma across the
profit. population of customers, one parameter of the
A second measure of profit concentration is gamma distribution, r, can act as an inverse
the Gini coefficient, which is the geometric area measure of purchase concentration. Mathemat-
between the 45-degree line and the Lorenz ically, 1/r is the squared coefficient of variation
curve divided by the total area under the 45- in purchase rates across customers. While this is
degree line (Sen, 1997). Mathematically, the to a useful measure of concentration, it is not as
Gini coefficient is one half of the relative mean easily computed or communicated as the more
difference — the mean of the absolute values of geometric-based measures described above.
the differences of all pairs of profit levels. For
the inverted Lorenz curve in Figure 5, we can
define a modified Gini coefficient as the area
between the curve and the 45-degree line di- STRATEGIC USES OF CUSTOMER
vided by the area under the 45-degree line PROFITABILITY MEASURES
(Storbacka, 1998). Compared with more sim- Customer profitability measures can be used for
plistic formulations (range, standard deviation, many marketing decisions at both a strategic
etc.), the modified Gini coefficient is attractive and a tactical level. Here we discuss uses of
because it is based on the differences in profit customer profitability for market segmentation
of all pairs of customers as opposed to the over- and resource allocation decisions.
35
JOURNAL OF INTERACTIVE MARKETING
O ~p O mc
J K
customer if it were known that sales calls to that
ijt 2 c ijt! 2 ikt .0 (4) customer were completely unrelated to pur-
j51 k51
chase behavior. Table 3 shows how profitability
and responsiveness can be combined to form
At a more advanced level, several segments target segments that can facilitate resource allo-
maybe formed based on customer profit. For cation. Knowledge of both profitability and re-
example, one may identify a best customers seg- sponsiveness of customers can help a firm lever-
ment consisting of the highest-profit customers age its marketing efforts in a more profit-
for whom extensive retention programs could maximizing manner that analytic approaches
be developed. Another valuable segment is less based solely on market-level responsiveness that
profitable customers who are similar to the best prevail in the literature (Hanssens, Parsons, and
customers in purchasing pattern of general Schultz, 1990).
characteristics. Programs can be developed to We note one additional measure that per-
migrate these customers to higher levels of prof- tains to resource allocation with respect to the
itability. value of a customer of an organization. Custom-
Segmentation analysis performed with stan- ers sometimes vary in terms of the degree to
dard basis, exclusive of an economic measure of which they can be replaced. Customers who are
profit, often yield segments that are not eco- easily replaced, even if they have very high
nomically viable to the firm. Thus customer profit levels, are not as attractive for marketing
profit adds information to existing segmenta- efforts as high-profit customers who are difficult
36
CUSTOMER PROFITABILITY ANALYSIS
TABLE 3
Combining Customer Profitability and Responsiveness for Market Segmentation
to replace. To incorporate replacement cost quency, and variable costs, there are other, non-
into a profitability analysis, the measure known economic factors that are likely to relate to
as Tobin’s q can be applied. Tobin’s q is the profitability. For example, Reichheld (1996)
ratio of the market profit of an investment to claims that the profitability of a customer in-
the replacement cost (Hayashi, 1982). Convert- creases over the tenure of a customer relation-
ing absolute profitability measures to Tobin’s q ship because variable costs decline and pur-
can direct resource allocations to customers chases may become more concentrated with a
based both on their profitability and replace- single seller. Another factor that may relate to
ability. customer profitability is customer satisfaction.
Anderson et al. (1994) find a relationship be-
tween customer satisfaction, measured at the
DISCUSSION AND FUTURE RESEARCH individual customer level, and firm profitability,
This paper establishes a foundation for measur- measured at the firm level. Implicit in this find-
ing customer profitability and assessing dispar- ing is that satisfaction at the individual cus-
ity of profitability across customers. As de- tomer level is correlated with individual cus-
scribed above, customer profitability is an tomer profitability. This relationship exists
important component for marketing practices because more satisfied customers are likely to
that involve communicating with individual cus- be more profitable because they may be less
tomers, particularly with interactive media. A price sensitive, and less prone to purchase from
great deal of additional research is required to competitors. This relationship is also likely to
develop a knowledge base in three important exist at the individual customer level. In the
areas: (1) what factors act as determinants of context of a customer orientation, customer
customer profitability (as in a scoring model in profitability is likely to be greatest for customers
direct marketing [Shepard, 1990]), (2) what whose needs are best satisfied by the product
factors determine the degree of disparity of offering. In fact, early proponents of the mar-
profits across customers, and (3) how customer keting concept emphasized that a profit focus as
profitability measures should be incorporated opposed to a sales volume focus as one of the
into marketing planning. elements of the marketing concept (Bell and
While profitability is obviously an outcome of Emory, 1970). However, only now, with the
prices, unit costs, unit volume, purchase fre- availability of customer databases, can customer
37
JOURNAL OF INTERACTIVE MARKETING
TABLE 4
Suggested Research Propositions
profitability be easily measured and included in would elevate customer profitability models to a
consumer-oriented marketing strategies. recursive level and would allow organizations to
Customer profitability is also likely to be de- develop a systematic approach to managing re-
termined by several other behavioral factors in- lationships with customers in a profit maximiz-
cluding price sensitivity, brand loyalty, and pur- ing fashion. Table 4 provides a list of research
chase timing, as well as perceptual factors such propositions drawn from this section that can
as perceived value, brand attitude, and attitude guide empirical research on customer profit-
toward advertisements. Empirical research in ability.
needed to determine if, and under what condi- One methodological area in need of research
tions, factors such as these relate to customer concerns the prediction of individual customer
profitability. purchasing behavior so that lifetime models can
Research is also needed to explore the distri- be calibrated. While the direct marketing liter-
bution of customer profitability across customers. ature has explored many aspects of lifetime
The distribution of profitability is likely to vary profitability models, there is little research that
dramatically for different brands, products and develops methods for accurately forecasting in-
industries. For example, Schmittlein et al. (1993) dividual customer purchase behavior. Such
find that profit concentration levels differ across a forecasting is subject to a great deal of error
variety of consumer packaged goods. Identifica- because of the stochastic nature of individual
tion of what determining factors relate to the purchase decisions. Research building on the
degree of disparity in profitability can help man- work by Schmittlein and Peterson (1994)
agers understand how marketing efforts relate to should help address this problem.
profitability at the customer level. The degree of
disparity is likely to be influenced by factors such
as the breadth of assortment and prices offered CONCLUSION
and the heterogeneity of customers needs and Customer profitability analysis has important
buying behaviors. Further research in needed to implications for marketing decision-making.
identify how such factors influence the disparity Knowledge of the profitability of individual cus-
of profitability across customers. tomers can help organizations segment mar-
A great deal of research in marketing has kets, allocate marketing resources and specify
explored how sales levels and market share re- marketing mix elements in a way that returns
spond to marketing efforts. What is needed is a high levels of profits. In the previous section we
similar stream of research for how customer noted two straightforward uses of customer
profitability relates to marketing efforts. This profitability measures—market segmentation
38
CUSTOMER PROFITABILITY ANALYSIS
and marketing resource allocation. Further re- keting: Exploiting the Age of Addressability. Sloan
search is needed to build theories and models Management Review, 5–14.
of marketing practice that incorporate cus- Blattberg, R.A. & Deighton, J. (1996), Manage Market-
tomer profitability. ing by the Customer Equity Test. Harvard Business
The inclusion of customer profitability in mod- Review (July-August), 136 –144.
els for segmentation and other marketing prac- Day, G.S. & Wensley, R. (1983). Marketing Theory With
tices can focus attention more on the manage- a Strategic Orientation. Journal of Marketing, 47
(Fall), 79 – 89.
ment of customers. This perspective represents a
substantial change in the way organizations think Deighton, J., Peppers, D., & Rogers M. (1994), Con-
about their markets. Much of marketing today is sumer Transaction Databases: Present Status and
Prospects. In Robert A. Blattberg, Rashi Glazer, &
defined by, and acted on, in terms of the market-
John D. C. Little (Eds.), The Marketing Information
ing mix variables. In practice, the marketing man- Revolution. Boston: Harvard Business School Press,
ager’s function to manage the variables repre-
Dwyer, F.R. (1989). Customer Lifetime Profitability to
sented by the 4 Ps. The use of customer databases Support Marketing Decision Making. Journal of Di-
to measure individual customer profitability helps rect Marketing, 3(4), 8 –15.
shift the emphasis from managing marketing mix Feick, L.F. & Price, L. L. (1987). The Market Maven:
variables to managing customers. This shift facili- The Diffuser of Marketplace Information. Journal of
tates the implementation of the marketing con- Marketing, 51 (January), 83–97.
cept which, despite its central presence in market- Foster, G., Gupta, M., & Sjoblom, L. (1996). Customer
ing theory, is not actively practiced by many Profitability Analysis: Challenges and New Direc-
organizations. As an operational tool, customer tions. Journal of Cost Management, 10 (Spring), 5–
profitability analysis fits well into the customer/ 17.
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