Electronic copy available at: http://ssrn.

com/abstract=2052662



MODELING AND MAXIMIZING CUSTOMER EQUITY

Keywords: customer equity; customer acquisition; customer retention;
customer expansion




Jose Carlos Fioriolli
Professor of Marketing
Management School
Federal University of Rio Grande do Sul
Washington Luiz St., 855 90010-460, Porto Alegre/RS, BRAZIL
Ph: (55) 51 3308-3536, Fax (55) 51 3308-3991
E-mail: jcfioriolli@ea.ufrgs.br






Working Paper - May 2012
Electronic copy available at: http://ssrn.com/abstract=2052662


2
MODELING AND MAXIMIZING CUSTOMER EQUITY
ABSTRACT
One of the most efficient criteria for achieving an optimal balance of resources among
customer acquisition, retention and expansion efforts is the maximum customer equity. In this
article the author proposes a new solution for the customer equity maximization problem. The
proposed solution takes into account two elements not considered in the majority of customer
equity models in the literature: (i) the customer expansion concept and (ii) acquisition,
retention and expansion floor rates. The article presents a double-phase model that employs a
variation of the Lagrange multiplier method to solve this balancing challenge. Its main
contribution consists in providing a more comprehensive framework for optimizing the
balance among customer acquisition, retention and expansion investments. The new approach
contributes also for improving customer relationship management (CRM) decisions.
Additionally, it represents appropriately the complexity of relationships among the customer
equity core variables.

Electronic copy available at: http://ssrn.com/abstract=2052662


3
INTRODUCTION
Marketing theory and practice are changing as a result of the worldwide economys
new profile. The impacts generated by market transformations, where services constitute the
predominant activity in the majority of national economies, have required firms to place more
emphasis on activities that build sustainable competitive advantages. In most cases these
efforts materialize in form of marketing investments, carried out in conditions of extreme
uncertainty. This fact has contributed to de-characterizing the cause-effect relations existing
between these investments and the respective returns obtained by the firms, making it
difficult or even impossible to identify and quantify those relations.
In an effort to minimize these difficulties, several studies have been carried out with
the objective of identifying and quantifying the variables that determine the nature and
intensity of the relationship between marketing investments and firm profitability. In recent
years, a variety of work has been done towards this end, using an approach centered on
customer equity (Blattberg and Deighton 1996; Berger and Nasr 1998; Gupta, Lehmann, and
Stuart 2004; Libai, Narayandas, and Humby 2002; Rust, Lemon, and Zeithaml 2004; Seggie,
Cavusgil, and Phelan 2007; Villanueva, Yoo, and Hanssens 2008; Petersen et al. 2009).

For the purposes of this paper, aligned with Blattberg and Deighton (1996) and Berger
and Bechwati (2001), the author defines customer equity (CE) as the present value of the
expected cash flows from the customer to the firm over time. The definition adopted by
Berger et al. (2002), though succinct, succeeds in objectively transmitting the same idea: CE
is the value that customers generate for the firm over the course of life. The basic premise of
CE is that customers are a financial asset that firms should individualize, measure, manage
and maximize just like any other asset it possesses (Blattberg, Getz, and Thomas 2001).
Starting from models that quantify the direct effects produced by marketing actions on
CE, the return on a firm's marketing investments can be estimated on the long term. A model


4
is a representation of the most important elements perceived in a real world system. Good
models show more than just the nature of the relationships existing among the variables, but
also the magnitude of their effects (Leeflang et al. 2000).
The increased complexity of a marketing environment can make it worthwhile to
analyze the data using quantitative models instead of the usual treatment in the form of tables
or statistical techniques (Franses and Paap 2001). A quantitative model serves three main
purposes: (i) improve the description of the phenomenon in focus; (ii) increase forecasting
precision and; (iii) support the decision making process. The improvement of the description
generally refers to the investigatory process regarding which explanatory variables have a
statistically significant impact on the dependent variables. Once these variables and their
respective impacts have been identified, the forecasting (elaborated based on the explanatory
variables identified as relevant during the modeling process) tends to be more precise, and
can thereby contribute more productively to increasing confidence in and quality of the
decision making process (Franses and Paap 2001, p. 12).
In this sense, a proposal for a quantitative model that makes it possible to identify in
which conditions the CE can reach its maximum value (providing simple, fast and precise
solutions as to how to optimally balance customer acquisition, retention and expansion
efforts) constitutes an important contribution to understanding and applying the concept of
CE, in both academic and business contexts.
In addition to this introduction, the article contains seven more sections. The next
section contains a review of the main topics related to CE and to balancing customer
acquisition, retention and expansion investments. The third section presents the first part of
the mathematical development of the new CE maximization model (specific to environments
without budget constraints). In the same section, the initial model is validated using the
results of its application without constraints and the respective results encountered via the


5
non-linear Generalized Reduced Gradient (GRG) optimization algorithm. The fourth section
presents the second part of the CE maximization models development (general model, valid
for all environments, regardless of the degree of budgetary constraints). In the fifth section, it
is applied a numerical example of the proposed model in its final form. The sixth section
analyzes the maximum CEs sensitivity in the face of possible variations in budget
availability. In the seventh section, the managerial implications of the new model are
presented and at the end, the last section shows this works main limitations, conclusions and
several suggestions for future research in the field.

BACKGROUND
This section presents the main drivers that define the scope of CE, as well as the
importance of this for achieving alignment between strategic decisions and the operational
activities developed by firms, and the main research related to integrating CE into the process
of identifying answers to the problem of optimal balance among customer acquisition,
retention and expansion efforts.

Scope and Importance of Customer Equity
Different metrics can be used to support the development of entrepreneurial
guidelines more strongly geared towards the market. According to Ambler (2003), a majority
of firms develop their approach to marketing performance evaluations, especially regarding
their benefits, in five stages: (i) the firm does not place importance on this activity; in this
stage, marketing is not seen formally, as something that requires executives special attention;
(ii) the evaluation is seen on financial terms and prioritizes analyses of earnings and losses
and cash flow; (iii) the exclusively financial measures are recognized as inadequate and many
non-financial measures are adopted, generating confusion in these firms; (iv) the firm places


6
its focus on the market and combines financial and non-financial metrics, although without
being certain they are using the appropriate metrics; and (v) a scientific method for evaluation
is adopted, allowing the databases and metrics to be analyzed mathematically in such a way
as to generate a reduced list of metrics with a high explanatory and predictive capacity. Firms
which systematically employ the concept of CE in their decision making processes can be
considered to be fifth stage organizations.
In these conditions, CE can be used in ways that present advantages in comparison
with other metrics, providing criteria that aid managers in identifying the main motives
associated with a customers decision to buy a product or not. Customers decide to buy from
a firm based on three fundamental factors: (i) the firms product is a better value than the
competitors; (ii) the firm has the better brand or (iii) the cost of change is very high (Lemon,
Rust, and Zeithaml 2001).
In order to facilitate understanding regarding the scope of CE, it is important to
identify and describe its primary drivers. According to Rust, Zeithaml, and Lemon (2000),
there are three dominant drivers that define CE:
(i) value equity, which corresponds to objectively evaluating a brand's utility,
developed by the customer starting from their perception of what he/she gives in
exchange for what he/she receives (Rust, Zeithaml, and Lemon 2000);
(ii) brand equity, which corresponds to the subjective evaluation developed by the
customer regarding the firm and the goods and services it provides, influenced as
much by the strategies adopted by the firm as by the customer's experiences with
respect to the firm providing them, including the history of brand associations and
memory (Yoo and Hanssens 2005; Rust, Zeithaml, and Lemon 2000); and
(iii) relationship equity, which corresponds to customers tendency to stay with a
determined brand, without regard to objective and subjective evaluations about it,


7
due to influence from recognition, valorization and socialization actions promoted
by the firm in possession of the brand (Bolton 1998; Rust, Zeithaml, and Lemon
2000).
CE is a concept that is still unknown to many firms and has been studied very little in
the academy. Villanueva and Hanssens (2007) presented a survey of the number of studies
about brand value and about CE conducted in recent years. While studies on brand value
correspond to approximately 50% of the published studies, proposals to quantify CE
correspond to only 5% of the total production presented. This is due to the fact that the
subject is relatively new to the literature.
Gradually recognizing the importance of the customer-centered approach to firms
decision making processes, researchers have studied CE and its application in a variety of
situations that require marketing decisions such a pricing strategies, media selection,
customer attraction programs and methods of determining optimal media budgets. Other
authors, like Slater, Mohr, and Sengupta (2009), have adopted a line of complementary
research, seeking to identify which activities are most critical to CE maximization. In their
opinion, identifying the customers with the greatest return potential, development of
customer acquisition strategies and development of integrated customer portfolio
management strategies can be considered prerequisites for CE to reach its maximum values.
A series of articles can be found in the literature that analyzes the alignment between
strategic decisions and operational activities, directly or indirectly using the concept of CE.
Kumar, Lemon, and Parasuraman (2006, p. 89) stated that it is not enough to come up with a
solid customer management strategy, firms need to develop models and metrics that make it
possible to verify if the strategy is effective. Gupta and Lehmann (2003) have suggested that
customers, as assets that are critical to a firms' success, should be constantly measured and
managed. Hanssens, Thorpe, and Finkbeiner (2008) defend the idea that the connections


8
between strategic objectives (such as CE maximization) and tactical objectives (such as direct
mailing) don't need to be merely logical: they can be quantified. In accordance with Hogan,
Lemon, and Rust (2002), CE is more than just an indicator; it is an integrated marketing
approach that can contribute to the creation of successful strategies. Bell et al. (2002) are
more emphatic: they state that managers need to implement marketing initiatives that
maximize customer value.
Since the publication of the first articles on quantitative CE models, interest in the
study of its maximization has been growing. Bell et al. (2002) have identified a series of
barriers (characterized as challenges) that can make the full implementation of the CE
concept by academic and entrepreneurial environments difficult. Among the challenges
(seven in all) they referred to, there is one that deals with the CE maximization problem.
Complementarily, it is worth pointing out that there are authors that are developing a
broader line of research, trying to establish relationships between CE and a firm's value.
Although this matter is not dealt with in this article, several of these papers are mentioned
below.
Based on the results of a study involving North American and European
organizations, Bayn and Becker (2004) defend the use of CE as a means of predicting the
future performance of a firms shares, characterizing it as an important decision making
criterion for allocation of resources. Bauer, Hammerschmidt, and Braehler (2003)
demonstrate that the possibility of combining and incorporating CE concepts and shareholder
value (SHV) into the process of determining a firm's value is due to the fact that CE
constitutes the central part of the processes that generate cash flow. SHV is defined as the
present value of firms future cash flows plus the value of its non-operating assets, minus its
future claims. In the same sense, Bauer and Hammerschmidt (2005) use a non-traditional


9
approach (separating cash flow down to the individual customer level) to propose a model
that incorporates the value of future customers into the SHV model.
Gupta, Lehmann, and Stuart (2004) have developed an approach that contributes to
estimating the current and future value of a customer base. These authors propose the use of
this estimate as a proxy of a firm's value. Broadening the scope of this approach, Rust,
Lemon, and Zeithaml (2004) propose a model for measuring return on investments that uses
CE as one of its central concepts; this proposal is considered one of the first attempts towards
financially accounting for marketing actions.
In the same manner as the authors previously cited, Pfeifer, Haskins, and Conroy
(2005) also suggest that CE can be used to establish a firm's value, but the warning presented
by Berger et al. (2006) is also worth pointing out, in the sense that many empirical
replications are necessary before CE can be widely adopted by corporations aiming at
defining their market value.

Balancing Customer Acquisition, Retention and Expansion Investments
A crucial question associated with the dissemination and effective implementation of
the concept of CE is related to the process complexity of identifying solutions to the problem
of optimal balancing customer acquisition, retention and expansion efforts. The main
approaches developed to this end and the results obtained by their respective authors are
presented as follows.
Blattberg and Deighton (1996) propose the use of CE as a central criterion for
determining the optimal balance between acquisition and retention resources (this optimal
point corresponds to the situation in which CE achieves its maximum value). In their model,
the authors use decision calculus (DC) to identify the limiting values related to the response
rates, although they do not consider acquisition and retention together. The DC approach


10
consists of a set of numerical procedures for processing

data and judgments to assist
managerial decision making (Little 1970). This treatment, by separating acquisition and
retention, makes the model fragile and restricts its possibilities for application. Still, the
structure of the solution proposed by these authors is quite consistent and can be used as a
starting point for the development of more precise models. Pfeifer and Carraway (2000)
present a general class of mathematical models that can be used to calculate CE. These
models are based on Markov processes, adapted to represent the dynamic of the customer
relationship with the firms as a function of their flexibility. Berger and Bechwati (2001)
develop a general approach to organizing media budget allocation, where the objective
function is to maximize CE. A key element of this research consists in the use of the DC
approach. The authors suggest that instead of evaluating the direct impacts of decisions on
sales or on profits, managers should ask themselves about the effects of their decisions and
consequential actions on the firm's CE. Thomas (2001) suggests that the customer acquisition
process affects the retention process; this approach contributes to reduce the negative impact
of managerial decisions made without taking their interdependence into account.
Calciu and Salerno (2002) present a variety of examples of CE maximization, though
they are all developed through graphic or interactive processes. Comprehensive solutions are
not presented for the examples. Libai, Narayandas, and Humby (2002) propose a stochastic
model which uses the concept of customer profitability on the industry segment level. The
proposal is an alternative to the individual approach, which is difficult to implement. Pfeifer
(2005) demonstrates that defining the optimal rate of customer acquisition and retention
resource allocation depends on the concepts used (average costs or marginal costs). Reinartz,
Thomas, and Kumar (2005) propose a statistical model (probit) for maximizing customer
profitability based on the optimal balance of resources destined to customer acquisition and
retention. The modeling establishes relationships among customer acquisition, customer-firm


11
relationships duration and profitability. The authors present the results of a series of
simulations, though they do not succeed in verifying if the investments in acquisition are
more critical than the investments in retention, except for the particular case they studied.
Ayache et al. (2007) present an analytic solution for optimal balancing of customer
acquisition and retention efforts starting from the CE maximization problem proposed by
Blattberg and Deighton (1996). The positive aspect consists in using a simple response
function (retention) and is easier to put into practice than the function used by Blattberg and
Deighton (1996). The solution is deficient in terms of structure, in that it does not
contemplate the investments in customer expansion and their respective impact on CE value.
Dong, Swain, and Berger (2007) present a model for broader CE maximization,
starting from Blattberg and Deightons (1996) model. They begin with the premise that the
channels vary in quality and that the customer acquisition and retention response curves
(obtained through the respective functions) can take on different shapes. Although it presents
the decision making problem more realistically, the solution presented is dependent on an
interactive approach (an objective function should be maximized using the Operational
Research tools). Additionally, they do not consider investments in customer expansion and
the respective response rate. Kumar and George (2007) analyze different approaches to
quantifying CE and propose a hybrid model that is able to integrate different levels of
aggregation used in the approaches studied. They deal with CE maximization but do not
present any analytic solution to this problem. Bruhn, Georgi, and Hadwich (2008) focus on
the question of CE maximization; although they present a proposal for identification and
quantification of activities that contribute to this maximization, they dont formally establish
the level of ideal effort for reaching maximum CE. Calciu (2008) proposes a mathematical
development focused on optimizing customer acquisition and retention costs. The generic
formulas proposed are derivatives of a simplified retention response function, with a structure


12
that makes it possible to identify an analytic solution for the problem. However, that paper
does not contain formal elements related to expansion efforts.
Upon analysis of these studies (approaches to balancing efforts and CE
maximization), it can be affirmed that only Blattberg and Deighton (1996), Ayache et al.
(2007), and Calciu (2008) present proposals oriented towards identifying analytic solutions
for the problem of optimal customer acquisition and retention resource balancing. The results
of the research conducted by these authors constitute a relevant contribution to improving
modeling processes in the field of marketing, especially related to CE maximization.
However, the deficiencies identified in these proposals should not be underestimated:
balancing the resources for customer acquisition and retention obtained in an inadequate
manner, through separate treatment of intervening variables (Blattberg and Deighton 1996);
absence of formal elements related to investments in customer expansion (Blattberg and
Deighton 1996; Ayache et al. 2007; Calciu 2008) and the impossibility of dealing with
situations where investments while null on the short term do not necessarily imply null
response rates (Blattberg and Deighton 1996).

CUSTOMER EQUITY MAXIMIZATION MODEL (PART ONE)
Similarly to the paper presented by Berger and Bechwati (2001), this article presents
elements suggesting that managers can benefit from adopting a customer-centered marketing
management. In this sense, the objective of maximizing CE is not merely recommendable, it
is necessary to a firms success.
This articles main contribution consists in developing a more comprehensive model
that makes it possible to maximize CE and identify optimal balance for resources destined to
customer acquisition, retention and expansion. Complementarily, the proposed model opens
new perspectives towards the study of the impact that these variables (acquisition, retention


13
and expansion) have on CE, especially when it is nearing its maximum value. Usually,
optimization problems like this one are dealt with via Operational Research, in which an
objective function associated with CE is maximized according to the constraints established
by the media budget, imposed by the firm-market environment.

Structure of the Initial Model
This article proposes a new approach for the customer equity measurement problem;
this simplifies the process of identifying maximum CE (and the conditions in which this
value occurs), as well as reducing the time it takes to obtain a response and makes it feasible
to analyze with a sensitivity that has been, until now, practically impossible (high complexity
and excessive processing time, resulting from the innumerous possible combinations, which
is characteristic of problems dealt with via Operational Research).
The structural CE model used in this research is presented in Figure 1. It consists of
an adaptation of Blattberg, Getz, and Thomas (2001, p. 11) by incorporating the broader
concept of customer expansion, as proposed by Gupta et al. (2006, p. 140). With this
adaptation, the customer expansion concept has the same status as the concepts of acquisition
and retention.

< Insert Figure 1 here >

Customer acquisition, from a transactional perspective, includes all the activities that
culminate in the first purchase (Blattberg, Getz, and Thomas 2001). Retention corresponds to
customers' continuing to engage in the process of purchasing products from the firm for a
determined period. Efforts towards retention are accounted for beginning after the first
purchase and continuing over the course of time the relationship persists. Complementarily,


14
customer expansion is an activity associated with the sales of any additional products (related
to each other or not) to current customers; in this way, they are efforts directed at retained
customers and constitute what can be called the third movement of CE management, with the
first two being acquisition and retention, respectively (it is common for expansion operation
to be done predominantly, through add-on selling efforts).
In order to calculate CE, the point of departure used is the procedure employed by
Blattberg and Deighton (1996), introducing the following modifications:
i) incorporation of the customer expansion concept;
ii) alteration of the response function structure (acquisition, retention and expansion)
considering the possibility of using floor rates, in such a way as to facilitate the
treatment of situations where investments, while null on the short term, do not
necessarily imply null response rates.
Similarly to what has been proposed by Blattberg, Getz, and Thomas (2001), the
author adopted the premise that the gross margins, investments and customer acquisition,
retention and expansion rates remain constant over time.

Development of the Initial Model
The mathematical model for the CE proposed in this study expands on the model
presented in Blattberg and Deighton (1996), and comes to consider investments and the
respective customer expansion rate as well. Notations used in the partial and final models
presented in this paper were standardized, as detailed in Table 1 (Entry variables), Table 2
(Intermediate and final variables), Table 4 (CE maximization variables) and Table 8 (CE
maximization variables with budget constraints).

< Insert Table 1 here >


15

< Insert Table 2 here >

The amplitude of the customer acquisition, retention and expansion rates, expressed in
Equations (1), (2) and (3), correspond to the differences between the respective ceiling and
floor values, as follows:
[c] [f ] acq acq acq
i i i = (1)
[c] [f ] ret ret ret
i i i = (2)
[c] [f ] add add add
i i i = (3)
Customer acquisition, retention and expansion rates are calculated using response
functions similar to those used by Blattberg and Deighton (1996). The alterations made in the
structure of the response functions (acquisition, retention and expansion) make it possible to
use floor rates, in such a way as to make it feasible to deal with situations in which
investment return, while null on the short term, does not necessarily imply null rates.
[c]
exp( )
acq acq acq acq
i =i i k ACQ (4)
[c]
exp( )
ret ret ret ret
i =i i k RET (5)
[c]
exp( )
add add add add
i =i i k ADD (6)

CE is calculated in accordance with the structure presented in Table 3.

< Insert Table 3 here >



16
A firms CE is obtained by (i) accounting for the income from each period and
respective costs; and (ii) applying the discount factor for the period contemplated, according
to what is presented next.
( ) ( )
( 1)
1 1
(1 ) (1 )
ret
t
t
T T
ret
acq acq ret add add ret t
t t d d
i
i
FCE= N i M M +i M RET +i ADD ACQ
i i

= =
(
| |
| |

( +
| ` |
|
+ +
(
\ \
)

(7)

The Equation (7) can be rewritten as follows:

( ) ( ) ( )
{ } acq acq ret add add ret ret
FCE = N i M + M +i M ADD i RET d i ACQ (

(8)

From the definition of the CE ( / CE = FCE N ) it follows that:

( ) ( ) ( )
acq acq ret add add ret ret
CE =i M + M +i M ADD i RET d i ACQ (

(9)

Observe that the CE value depends on the total budget for customer acquisition,
retention and expansion, on the respective rates and gross margins and on the discount rate
used. Table 4 presents the notation used to model maximum CE.

< Insert Table 4 here >

In this optimization process, starting with Equation (9), the first partial derivative of
the CE is calculated with respect to customer expansion investments as follow:



17
( ) exp( ) 1
acq ret add add add add
ret
i i i k M k ADD
CE
=
ADD d i

(10)

The value of ADD that maximizes CE is obtained by making this derivative equal to
zero, as follows.
[max ]
= ( )
CE add add add add
ADD ln i k M k (11)

Substituting in Equation (6), the customer expansion rate that maximizes CE is
calculated.
[max ] [c]
1/( )
add CE add add add
i =i k M (12)

Incorporating these values [Equations (11) and (12)] into Equation (9) and calculating
the first partial derivative of the CE with respect to the investment in customer retention:

( ) ( )
( )
[max ] [c]
2
[c]
( ) 1
acq ret CE ret ret
ret ret
i i U d RET k d i
CE
=
RET
d i i
(

+
(13)

where
[max ] [max ] [max ] CE ret add CE add CE
U = M +i M ADD and exp( )
ret
k RET = .

Once again, equaling the derivative to zero, the expression which makes it possible to
calculate the RET in the condition of maximum CE is:
( ) ( )
[max ] [c]
( ) 1
ret CE ret ret ret
RET ln i U d RET k d i k
(
=

(13a)



18
The RET value can be found by applying (separately or together) the following
solution methods:
i) Develop an interactive process, starting with RET = 0 and completing the study
when the RET value converges to
[max ] CE
RET .
ii) Calculate [ ]
[max ] 1 2 1
( )
CE ret
RET =ln V V ln V k
where
1 [max ] [c]
( 1) ( )
ret CE ret ret
V = i U dk d i and

( ) ( ) ( )
2 [c] [max ] [max ]
2 1
ret ret CE ret CE ret
V = i d i U dk U dk
( (



The solution (i) refers to an Operational Research problem. In these cases, the result
cannot be expressed analytically, since it depends on interactive research, having CE
maximization as its objective function. The second solution (ii), with a closed structure, will
be used in this study because of its analytical nature. This function constitutes an original
contribution to CE maximization modeling; it was obtained by means of a synthetic proof
(using computational simulation). Thus, the expression proposed for determining the
investment that maximizes CE with respect to customer retention is:

[ ]
[max ] 1 2 1
( )
CE ret
RET =ln V V ln V k (14)

The customer retention rate (in the CE maximization condition) is obtained by
combining Equations (5) and (14).
[ ]
[max ] [c] 1 2 1
( )
ret CE ret ret
i =i i V V ln V (15)

Incorporating Equations (11), (12), (14) and (15) into Equation (9) and deriving
partially with respect to the investment in customer acquisition, the final expression is:



19
[max ]
*
exp( ) 1
acq CE
acq acq acq
CE
= i k k ACQ M
ACQ

(16)

where
( ) ( )
[max ]
*
[max ] [max ] [max ] [max ]
acq CE
acq CE ret CE CE ret CE
M = M + U i RET d i corresponds to
the new margin associated with customer acquisition and adjusted by way of incorporation of
the values calculated in the Equations (11), (12), (14) and (15).
Equaling this derivative to zero, the value of ACQ that maximizes CE and the
respective customer acquisition rate are:

[max ]
*
[max ]
( )
acq CE
CE acq acq acq
ACQ ln i k M k = (17)
[max ]
*
[max ] [c]
1/( )
acq CE
acq CE acq acq
i =i k M (18)

By substituting the expressions related to Equations (11), (12), (14), (15), (17) and
(18) in Equation (9), the new model for CE maximization (see Table 5) is defined, as follows.
( ) ( ) ( )
[max ] [max ] [max ] [max ] [max ] [max ] [max ]
max
acq CE acq ret add CE add CE ret CE CE ret CE CE
CE =i M + M +i M ADD i RET d i ACQ
(


(19)

The necessary budget for CE maximization corresponds to the sum of the values
expressed in Equations (11), (14) and (17).

[ ]
[max ]
*
[max ] 1 2 1
( ) ( ) ( )
acq CE
CE acq acq acq ret add add add add
B =ln i k M k +ln V V ln V k +ln i k M k (20)


< Insert Table 5 here >



20

Validation of the Initial Model
In order to validate the CE maximization model, several scenarios were analyzed.
Eight of these scenarios, contemplating several typical marketing situations, are represented
in Table 6.

< Insert Table 6 here >

Table 7 shows the results of CE maximization obtained through the Generalized
Reduced Gradient (GRG, operated in Excels Solver function) and the model proposed in
this article.

< Insert Table 7 here >

Note that the performance of the new model is extremely satisfactory (there are no
differences between the methods) for the eight scenarios considered. The results obtained in
the other tests presented the same performance level. In order to detail and obtain greater
comprehension of the GRG algorithm, the author recommends consulting the work of Lasdon
et al. (1978).

CUSTOMER EQUITY MAXIMIZATION MODEL (PART TWO)
Although the model for CE maximization may have presented excellent performance,
the question of balancing budget allocation between customer acquisition, retention and
expansion efforts has yet to be answered. There are cases where the available budget (
[lim]
B )
is less than the ideal/necessary budget for optimizing CE (
[max ] CE
B ), as defined by Equation


21
(20). In these circumstances, might it be possible to establish an optimal balance of these
limited resources by simply distributing them in the same proportion as established for the
ideal budget (according to the model presented in Table 5)? The answer to this question is:
probably no. As the response functions for acquisition, retention and expansion are not linear
(Kumar 2008), the condition of optimality achieved with the ideal budget will most likely not
stay whole. This is where the need arises to develop a complementary model that makes CE
maximization feasible in situations in which the available budget is less than ideal (this
condition
[lim] [max ] CE
B B < is common in business environments). Table 8 presents the notation
used in this model.
This is a new CE maximization problem, and is subject to a set of budget constraints.
Seeking for an analytic solution, the author uses the Lagrange multiplier method. This
approach is frequently used to solve problems of conditioned optimization (Hughes-Hallett et
al. 1999).
The usage of Lagrange multipliers method involves the calculation of the first partial
derivatives of the CE with respect to investments in customer acquisition, retention and
expansion. These derivatives correspond, respectively, to the following expressions:

*
exp( ) 1
acq
acq acq acq
CE
= i k k ACQ M
ACQ

(21)

where: ( ) ( )
*
( )
acq
acq ret add add ret ret
M = M + M +i M ADD i RET d i

( ) ( )
( )
[c]
2
[c]
( ) 1
acq ret ret ret
ret ret
i i Ud RET k d i
CE
=
RET
d i i
(

+
(22)

where:
ret add add
U = M +i M ADD and exp( )
ret
k RET =



22

( ) exp( ) 1
acq ret add add add add
ret
i i i k M k ADD
CE
=
ADD d i

(23)


< Insert Table 8 here >

The value of the Lagrange multiplier, , is identified by using the first partial
derivatives of the CE and considering B= ACQ+RET + ADD as follows.

CE B
=
ACQ ACQ

(24)

( ) ( ) exp( ) ( ) 1
1 exp( )( ) /( )
acq acq acq acq ret add add ret ret
acq acq acq ret ret
i k k ACQ M + M +i M ADD i RET d i
=
i k k ACQ RET +i ADD d i

(

+
(24a)

CE B
=
RET RET

(25)


( ) ( )
[c]
exp( ) (( ) ) 1
( ) exp( )
ret ret ret add add ret ret
ret ret ret ret
i k RET M +i M ADD d RET k d i
=
d i RET dADD i k k RET

+ +

(25a)

CE B
=
ADD ADD

(26)



23
exp( ) 1
add add add add
i k M k ADD = (26a)

Thus, investments in customer acquisition [Equation (27)] and customer expansion
[Equation (28)] can be obtained from Equations (24a) and (26a), respectively. The investment
in customer retention is calculated in a complementary manner, according to the expression
proposed in Equation (29).

( ) ( ) ( )
1 exp( )( ) /( ) 1
acq acq acq ret add add ret ret
acq
acq acq acq ret ret
i k M + M +i M ADD i RET d i
ACQ ln k
i k k ACQ RET +i ADD d i
(


=
`
( + +
)
(27)

1
add add add
add
i k M
ADD ln k

(
=
(
+

(28)

[lim]
RET B ACQ ADD = (29)

The method used to determine the value, as proposed next, constitutes an original
contribution. It consists of four steps:
i) calculation of the initial values
[0]
ACQ ,
[0]
RET e
[0]
ADD , using a proportionality
factor,
[ ] lim
Fator , equal to the ratio between the available budget (limited) and the
necessary budget (ideal); this factor should be applied to
[max ] CE
ACQ ,
[max ] CE
RET
and
[max ] CE
ADD , respectively;
ii) update of the values related to the acquisition, retention and expansion rates,
according to the initial calculated values;
iii) calculation of the initial values of the Lagrange multipliers, [
[0] acq
,
[0] ret
and
[0] add
], according to Equations (24a), (25a) and (26a); and


24
iv) calculation of

(estimate of the Lagrange multiplier), obtained as a function of

[0] acq
,
[0] ret
and
[0] add
.
The Equations in the [(30)-(40)] interval formalize the steps of the proposed model.

[ ] [lim] [max ] lim CE
Fator B B = (30)
[0] [ ] [max ] lim CE
ACQ Fator ACQ =

(31)
[0] [ ] [max ] lim CE
RET Fator RET = (32)
[0] [ ] [max ] lim CE
ADD Fator ADD =

(33)
[0] [c] [0]
exp( )
acq acq acq acq
i =i i k ACQ (34)
[0] [c] [0]
exp( )
ret ret ret ret
i =i i k RET (35)
[0] [c] [0]
exp( )
add add add add
i =i i k ADD (36)

Incorporating the initial calculated values [steps (i) and (ii)] into Equations (24a),
(25a) and (26a), the initial values of the Lagrange multipliers are calculated as follows.

( ) ( )
[0] [0] [0] [0] [0] [0] [0]
exp( ) ( ) 1
acq acq acq acq acq ret add add ret ret
= i k k ACQ M + M +i M ADD i RET d i (

(37)

( ) ( )
( )
[0] [0] [0] [0] [0] [c]
[0] 2
[c] [0]
exp( ) (( ) ) 1
exp( )
acq ret ret ret add add ret ret
ret
ret ret ret
i i k RET M +i M ADD d RET k d i
d i i k RET

(

=
+
(38)

[0] [0]
exp( ) 1
add add add add add
i k M k ADD = (39)



25
In order to estimate the value of the multiplier to be used in developing the final
model, the author proposes the use of a simple average [values defined in the Equations (37),
(38) and (39)]. The simple average is a central trend measure that is easy to put into
operation, capable of producing a fast convergence of values in situations like these, in which
the initial values of the Lagrange multipliers [generated in step (iii)] tend to be very close to
each other.
[0] [0] [0]

3
acq ret add

+ +
= (40)

Using the

multiplier [obtained in step (iv)], it is possible to generate a solution for

the system formed by Equations (27), (28) and (29). In this sense, the values
[lim]
ACQ ,
[lim]
RET and
[lim]
ADD (investments in customer acquisition, retention and expansion subject
to budget constraints) are defined which tend to maximize the firms CE, in accordance to the
following mathematical model:

( ) ( )
[0] [0] [0] [0] [0]
[lim]
( )

1
acq acq acq ret add add ret ret
acq
i k M + M +i M ADD i RET d i
ACQ =ln k

(


`
+

)
(41)

[0] [0]
[lim]
[0] [0] [0]

( )
acq ret add add add
add
ret acq ret
i i i k M
ADD ln k
d i i i
(

= (
+
(

(42)

[lim] [lim] [lim] [lim]
RET B ACQ ADD = (43)

The response rates are calculated as follows:



26
[lim] [c] [lim]
exp( )
acq acq acq acq
i =i i k ACQ (44)
[lim] [c] [lim]
exp( )
ret ret ret ret
i =i i k RET (45)
[lim] [c] [lim]
exp( )
add add add add
i =i i k ADD (46)

In this way, replacing the expressions relative to Equations (41), (42), (43), (44), (45)
and (46) in Equation (9), the final model for CE maximization is defined in conditions where
the budget is restricted (see Table 9). Its general form has the following structure:
( ) ( ) ( )
[lim] [lim] [lim] [lim] [lim] [lim] [lim] [lim]
max
acq acq ret add add ret ret
CE = i M + M +i M ADD i RET d i ACQ
(


(47)


< Insert Table 9 here >


NUMERICAL EXAMPLE
In this example, the environment is characterized by the set of data presented in Table
10. Floor rates, ceiling rates, and the impacts of customer acquisition, customer retention and
customer expansion investments on the respective response rates are obtained through the DC
approach, as described by Blattberg and Deighton (1996). The other values can be extracted
from the data bases maintained by the firm.
This firm invests an average of $9.00 in customer acquisition, $18.00 in retention and
$3.00 in expansion. The available budget of $30.00 generates a CE of $70.39.

< Insert Table 10 here >



27
Is this 9/18/3 distribution appropriate? Is this the greatest value that CE can assume in
this environment? If not, how far is it from the maximum value? How sensitive is CE to
changes of these proportions? How much should be invested in customer acquisition,
retention and expansion in order to maximize CE without disrespecting the budget constraints
($30.00 per customer/period)? In this optimized condition, what would the increase in CE
with respect to the initial value ($70.39)? These are important questions, for which the
majority of firms do not have answers and, for this reason, are creators of serious gaps of
knowledge that compromise the firms management. In order to minimize these difficulties,
the first step to be taken includes identifying the maximum CE value, without any budget
constraints. In this example, both the GRG algorithm and the proposed model presented the
same results: a budget of $49.24 increased the CE to its maximum value of $80.20. The
optimal balancing of efforts among customer acquisition, retention and expansion (identified
equally by the two methods) is obtained by investing $17.24 in customer acquisition, $24.68
in retention and $7.32 in expansion. In this manner, it is discovered that investments greater
than $49.24 will probably not produce increases in CE. At the same time, knowing the
differences between the effective values and the maximum values ($30.00 versus $49.24 for
the budget; and $70.39 versus $80.20 for the CE) the decision making processes related to
allocation of investments can be developed with greater speed and confidence.

ANALYSIS OF MAXIMUM CUSTOMER EQUITY SENSITIVITY
In this section, the sensitivity of the maximum CE values is checked against the
variations produced by different levels of budget availability. In this sense, Table 11 shows
the results obtained with the GRG algorithm and the results generated through the
maximization model proposed by this study. The environment (defined in Table 10) was


28
maintained, only altering the levels of budget availability (beginning with $25.00 and ending
with the ideal value of $49.24), in such a way as to facilitate the intended comparison.

<Insert Table 11 here>

It can be seen that even in situations where budgets are very restricted (availability of
resources approximately 50% of the ideal) the performance of the proposed model is highly
satisfactory. The respective pairs of values corresponding to maximum CE, in the worst
situation, present differences less than 0.6% (in the case of a budget of $25.00, equivalent to
50.77% of the ideal value). For availabilities 75% greater than the ideal, the differences
between the values for maximum CE are practically inexistent, being less than 0.1% (budget
equal to or greater than $38.00) according to information presented in Figure 2 (generated
with the maximum CE values that make up Table 11).
The questions presented in the fifth section (Numerical example) can be easily
answered by applying the solution proposed in this article (see Table 9), according to the two
examples presented below.
Q How much should be invested in customer acquisition, retention and expansion in
order to maximize CE without disrespecting the $30.00 per customer/period
budget restriction?
A It can be seen in Table 11 (columns of the Proposed Model) that the values that
maximize CE with a budget of $30.00 are, respectively: $13.08 for customer
acquisition; $14.92 for retention; and $2.00 for expansion. In this case, the
maximum CE is $74.60. The non-analytic solution, maximized with the GRG
algorithm, reached $74.82. Even in unfavorable circumstances, with an available
budget equivalent to 60.93% of the ideal budget ($30.00 versus $49.24), the


29
difference between the two methods is $0.22 (deviation less than 0.3% with
respect to the GRG algorithm solution).

Q In this condition of optimization with budget constraints, how might the CE
increase with respect to its initial value of ($70.39)?
A That would be $4.21 (difference between $74.60 and $70.39), approximately 6%
of the elevation in relation to the initial CE, with the same $30.00 available.

< Insert Figure 2 here >


MANAGERIAL IMPLICATIONS OF THE NEW MODEL
From a managerial perspective, more precise models of CE can serve as references, as
much for planning as for monitoring the administration of firm-customer relations. The
detailed and continuous accompaniment of CE evolution generates information that can assist
in analyzing the performance of a firms strategies, contributing to validating the marketing
strategy adopted. Managers, as they implement their marketing actions, need precise data and
objective information that guides them towards maximization of the value of their customer
base (Bell et al. 2002). In practice the use of this modeling reinforces this view and allows:
i) acceleration of the process of adopting the CE concept in firms;
ii) improve decisions related to management of their relationship with customers;
iii) contribute to identifying and quantifying the partial and general impacts
produced by marketing actions on the return obtained by the firm in the market;
iv) reduce the risks inherent to the process of financial resources allocation in the
realm of marketing;


30
v) support planning and execution of media budgets;
vi) facilitate decisions on choice of channel;
vii) subsidize the process of identifying more profitable customers, individually or by
segment;
viii) increase the use of managerial practices that are less sensitive to environmental
pressures, in the short term;
ix) contribute to valorization of the use of metrics in marketing;
x) make the interdependencies that involve customer acquisition, retention and
expansion clearer;
xi) value the firms databases, making them more productive;
xii) perfect the process of customer lifecycle management; and
xiii) evaluate the impact of the customer lifecycle in the strategies and in the firm's
marketing mix.

LIMITATIONS, CONCLUSIONS AND SUGGESTIONS FOR FUTURE STUDIES
In the current research, the author adopted the premise that the gross margins,
investments and customer acquisition, retention and expansion rates remain constant over
time. In models of highly complex systems, simplifications like these play a very important
role, since they make it feasible to build initial models, without which it would be very
difficult to move forward in building scientific knowledge to arrive at more potent models
that are more representative of reality. The premises used in this paper are similar to those
used by the authors consulted, although they should be reviewed and redefined in such a way
as to reduce, as much as possible, the distance between the models produced from them and
the real systems they represent.


31
The modeling developed and presented in this article maximizes CE and optimizes the
balance of investments in customer acquisition, retention and expansion. Built starting from
the approaches developed by Blattberg, Getz, and Thomas (2001) and Gupta et al. (2006), it
incorporates the investments in customer expansion into its structure in an innovative
manner. Its operation, inspired by the work of Blattberg and Deighton (1996), is extremely
simple and fast. It is different from the main approaches found in the literature; it makes a
solution feasible for a problem that had, until now, been solved by means of optimization
algorithms, based on interactive research. Its utilization can contribute to improving decision
making processes in the realm of customer relationship management.
The performance of the maximization model presented in this study is extremely
satisfactory. In environments where budget limitations are small or inexistent, the modeling
generates results that are identical to those obtained through non-linear research algorithms
(such as the GRG, used in this research), which confers it high explicative and predictive
capability. In so far as budget constraints increase and the resources available represent
increasingly smaller fractions of the ideal budget (necessary budget to non-conditioned CE
maximization), the model shows a slight drop in performance (differences that oscillated
between zero and 0.6% with respect to the CE value obtained by non-linear optimization
algorithms). In order to reduce possible risks in use of the model, the author suggests that its
use be restricted to situations in which the available budget is equal to or greater than 75% of
the ideal budget.
In so far as they contribute to building more precise metrics for the field of marketing,
the researchers help to establish new criteria and better perspectives for studying the cause-
effect relationships between marketing investments and the returns obtained by firms. To this
end, the author suggests the development of studies that contribute to establishing the


32
operational intervals for reliable use of this new model. In a more general sense, it stimulated
the incorporation of other variables to the processes of modeling CE maximization, such as:

i) variables representative of the competitive environment on CE, particularly on
the conditions in which this reaches its maximum point;
ii) stochastic variables to represent processes of purchase and repurchase;
iii) hybrid response functions (customer acquisition, retention and expansion) in
order to represent the interdependencies in a more adequate manner;
iv) stochastic rates and margins;
v) complementary metrics that contemplate the financial and production areas in
order to broaden the scope of the models and, with that, increase their speed of
dissemination in firms and improve their performance.

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39
Figure 1 Customer equity structure
















Investments
Customer
Life Cycle
Returns
Acquisition
Retention
Expansion


40
Table 1 Entry variables
Symbol Description
[f ] acq
i Customer acquisition floor rate
[c] acq
i Customer acquisition ceiling rate
[f ] ret
i Customer retention floor rate
[c] ret
i Customer retention ceiling rate
[f ] add
i
Customer expansion floor rate
[c] add
i
Customer expansion ceiling rate
acq
k Impact of acquisition investments on customer acquisition rate
ret
k Impact of retention investments on customer retention rate
add
k Impact of expansion investments on customer expansion rate
acq
M Average value of gross margin generated by new customers (1
st
purchase)
ret
M Average value of gross margin generated by retained customers
add
M Average value of gross margin generated by developed customers
d
i Discount rate (equivalent to the firms cost of capital)
ACQ Average customer acquisition investment
RET
Average customer retention investment
ADD
Average customer expansion investment
[ ] lim
B Available budget (limited) per customer
N Number of potential customers
T Temporal horizon (number of periods)



41
Table 2 Intermediate and final variables
Symbol Description
acq
i Amplitude of the customer acquisition rate
ret
i Amplitude of the customer retention rate
add
i Amplitude of the customer expansion rate
acq
i Customer acquisition rate
ret
i Customer retention rate
add
i Customer expansion rate
d
Discount (1
d
i + )
B
Budget
FCE Firms customer equity
CE Customer equity



42
Table 3 CE calculation structure
t Income Costs Discount factor
0
acq acq
i M ACQ 1
1
1
( )
ret
acq ret add add
i i M i M +
0
( )
ret
acq ret
i i RET i ADD +
1
1 (1 )
d
i +
2
2
( )
ret
acq ret add add
i i M i M +
1
( )
ret
acq ret
i i RET i ADD +
2
1 (1 )
d
i +
3
3
( )
ret
acq ret add add
i i M i M +
2
( )
ret
acq ret
i i RET i ADD +
3
1 (1 )
d
i +
... ... ... ...
T ( )
ret
T
acq ret add add
i i M i M +
( 1)
( )
ret
T
acq ret
i i RET i ADD

+ 1 (1 )
T
d
i +



43
Table 4 CE maximization variables
Symbol Description
[max ] CE
ACQ Average customer acquisition investment that maximizes CE
[max ] acq CE
i Customer acquisition rate that maximizes CE
[max ] CE
RET Average customer retention investment that maximizes CE
[max ] ret CE
i Customer retention rate that maximizes CE
[max ] CE
ADD Average customer expansion investment that maximizes CE
[max ] add CE
i Customer expansion rate that maximizes CE
[max ] CE
B Budget that maximizes CE:
[max ] CE
ACQ +
[max ] CE
RET +
[max ] CE
ADD
maxCE maximum customer equity



44
Table 5 CE Maximization
Resources allocation Rate
[max ]
*
[max ]
( )
acq CE
CE acq acq acq
ACQ ln i k M k =
[max ]
*
[max ] [c]
1/( )
acq CE
acq CE acq acq
i =i k M
[ ]
[max ] 1 2 1
( )
CE ret
RET =ln V V ln V k [ ]
[max ] [c] 1 2 1
( )
ret CE ret ret
i =i i V V ln V
[max ]
= ( )
CE add add add add
ADD ln i k M k
[max ] [c]
1/( )
add CE add add add
i =i k M
where:
1
d
d = + i

[max ] [max ] [max ] CE ret add CE add CE
U = M +i M ADD

( ) ( )
[max ]
*
[max ] [max ] [max ] [max ]
acq CE
acq CE ret CE CE ret CE
M = M + U i RET d i

1 [max ] [c]
( 1) ( )
ret CE ret ret
V = i U dk d i

( ) ( ) ( )
2 [c] [max ] [max ]
2 1
ret ret CE ret CE ret
V = i d i U dk U dk
( (






45
Table 6 Scenarios used in validating the proposed model
Variable
Scenario
1 2 3 4 5 6 7 8
[f ] acq
i 0% 1% 2% 3% 4% 5% 6% 7%
[c] acq
i 20% 20% 18% 18% 16% 16% 14% 14%
[f ] ret
i 50% 52% 54% 56% 56% 54% 52% 50%
[c] ret
i 70% 68% 66% 64% 64% 66% 68% 70%
[f ] add
i
0% 1% 1% 2% 2% 1% 1% 0%
[c] add
i
10% 9% 9% 8% 8% 9% 9% 10%
acq
k 0.15 0.10 0.15 0.10 0.15 0.10 0.15 0.10
ret
k 0.10 0.15 0.10 0.15 0.10 0.15 0.10 0.15
add
k 0.30 0.30 0.20 0.20 0.10 0.10 0.05 0.05
acq
M $200 $200 $200 $200 $200 $200 $200 $200
ret
M $250 $250 $250 $250 $250 $250 $250 $250
add
M $300 $300 $300 $300 $300 $300 $300 $300
d
i 18% 20% 22% 24% 24% 22% 20% 18%



46
Table 7 CE maximization without constraints (GRG versus proposed model)
Scenario
GRG (Excel/Solver)
a
Proposed Model
a

[max ] CE
ACQ

[max ] CE
RET

[max ] CE
ADD

maxCE [max ] CE
ACQ

[max ] CE
RET

[max ] CE
ADD

maxCE
01 18.32 24.68 7.32 79.12 18.32 24.68 7.32 79.12
02 22.57 17.44 6.58 68.01 22.57 17.44 6.58 68.01
03 16.02 18.40 7.84 60.22 16.02 18.40 7.84 60.22
04 19.07 12.10 6.40 51.72 19.07 12.10 6.40 51.72
05 13.73 13.74 5.88 49.32 13.73 13.74 5.88 49.32
06 16.34 14.96 8.75 48.18 16.34 14.96 8.75 48.18
07 11.55 21.27 3.65 47.75 11.55 21.27 3.65 47.75
08 12.81 18.88 8.11 49.17 12.81 18.88 8.11 49.17

a
values in $



47
Table 8 CE maximization variables with budget constraints (w.b.c)
Symbol Description
Lagrange multiplier
[ ] lim
Fator
The proportionality factor, equal to the ratio between the available budget and the ideal
budget
[0]
ACQ Initial value of the customer acquisition investment
[0] acq
i Initial customer acquisition rate
[0]
RET Initial value of the customer retention investment
[0] ret
i Initial customer retention rate
[0]
ADD Initial value of the customer expansion investment
[0] add
i Initial customer expansion rate
[0] acq
Lagrange multiplier associated with customer acquisition (initial value)
[0] ret
Lagrange multiplier associated with customer retention (initial value)
[0] add
Lagrange multiplier associated with customer expansion (initial value)

Estimate of the Lagrange multiplier
[lim]
ACQ Average customer acquisition investment that maximizes CE w.b.r
[lim] acq
i Customer acquisition rate that maximizes CE w.b.r
[lim]
RET Average customer retention investment that maximizes CE w.b.r
[lim] ret
i Customer retention rate that maximizes CE w.b.r
[lim]
ADD Average customer expansion investment that maximizes CE w.b.r
[lim] add
i Customer expansion rate that maximizes CE w.b.r
[lim]
B Available budget (limited) per customer equivalent to
[lim]
ACQ +
[lim]
RET +
[lim]
ADD
[lim]
maxCE Maximum customer equity in environments where budget constraints are present



48
Table 9 CE maximization with budget constraints
Item Proposed expressions
Investments
( ) ( )
[0] [0] [0] [0] [0]
[lim]
( )

1
acq acq acq ret add add ret ret
acq
i k M + M +i M ADD i RET d i
ACQ =ln k

(


`
+

)


[0] [0]
[lim]
[0] [0] [0]

( )
acq ret add add add
add
ret acq ret
i i i k M
ADD ln k
d i i i
(

= (
+
(



[lim] [lim] [lim] [lim]
RET B ACQ ADD =
Rates
[lim] [c] [lim]
exp( )
acq acq acq acq
i =i i k ACQ
[lim] [c] [lim]
exp( )
ret ret ret ret
i =i i k RET
[lim] [c] [lim]
exp( )
add add add add
i =i i k ADD
Model ( ) ( ) ( ) [lim] [lim] [lim] [lim] [lim] [lim] [lim] [lim]
max
acq acq ret add add ret ret
CE =i M + M +i M ADD i RET d i ACQ
(






49
Table 10 Data for the numerical example
Description Notation Value
Customer acquisition floor rate
[f ] acq
i 3%
Customer acquisition ceiling rate
[c] acq
i 20%
Customer retention floor rate
[f ] ret
i 50%
Customer retention ceiling rate
[c] ret
i 70%
Customer expansion floor rate
[f ] add
i
0%
Customer expansion ceiling rate
[c] add
i
10%
Impact of acquisition investments on customer acquisition rate
acq
k 0.15
Impact of retention investments on customer retention rate
ret
k 0.10
Impact of expansion investments on customer expansion rate
add
k 0.30
Average value of gross margin generated by new customers (1st purchase)
acq
M $200
Average value of gross margin generated by retained customers
ret
M $250
Average value of gross margin generated by developed customers
add
M $300
Discount rate (equivalent to the firms cost of capital)
d
i 18%
Average customer acquisition investment ACQ $9
Average customer retention investment
RET
$18
Average customer expansion investment
ADD
$3
Customer equity CE $70.39



50
Table 11 CE maximization without constraints (GRG versus proposed model)
Budget
($)
GRG (Excel/Solver) Proposed Model
ACQ
RET ADD maxCE ACQ
RET ADD maxCE
25.00 12.55 10.69 1.76 71.08 11.86 12.36 0.78 70.67
26.00 12.78 11.26 1.96 71.92 12.11 12.87 1.02 71.56
27.00 13.00 11.84 2.16 72.72 12.36 13.38 1.26 72.40
28.00 13.22 12.41 2.37 73.46 12.60 13.89 1.51 73.18
29.00 13.44 12.99 2.57 74.17 12.84 14.41 1.75 73.91
30.00 13.66 13.57 2.77 74.82 13.08 14.92 2.00 74.60
31.00 13.87 14.15 2.98 75.43 13.32 15.44 2.24 75.24
32.00 14.09 14.72 3.19 76.00 13.56 15.95 2.49 75.83
33.00 14.30 15.30 3.40 76.52 13.80 16.47 2.73 76.38
34.00 14.51 15.87 3.62 77.01 14.03 16.99 2.98 76.89
35.00 14.71 16.45 3.84 77.45 14.26 17.51 3.23 77.35
36.00 14.92 17.02 4.06 77.86 14.49 18.03 3.48 77.77
37.00 15.12 17.60 4.28 78.23 14.72 18.55 3.73 78.16
38.00 15.31 18.18 4.51 78.57 14.94 19.07 3.99 78.50
39.00 15.51 18.75 4.74 78.86 15.16 19.59 4.25 78.81
40.00 15.69 19.34 4.97 79.13 15.38 20.10 4.52 79.09
41.00 15.88 19.92 5.20 79.36 15.60 20.61 4.79 79.33
42.00 16.07 20.49 5.44 79.56 15.81 21.12 5.07 79.54
43.00 16.24 21.07 5.69 79.74 16.02 21.63 5.35 79.72
44.00 16.41 21.65 5.94 79.88 16.22 22.14 5.64 79.86
45.00 16.58 22.23 6.19 79.99 16.42 22.64 5.94 79.98
46.00 16.74 22.81 6.45 80.08 16.62 23.14 6.24 80.08
47.00 16.90 23.39 6.71 80.15 16.82 23.62 6.56 80.14
48.00 17.06 23.96 6.98 80.19 17.01 24.10 6.89 80.19
49.00 17.20 24.54 7.26 80.20 17.19 24.57 7.24 80.20
49.24 17.24 24.68 7.32 80.20 17.24 24.68 7.32 80.20



51
Figure 2 Budgetary availability and its impacts on maximum CE
70
72
74
76
78
80
82
30 40 50 60 70 80 90 100
Available budget (%)
M
a
x
i
m
u
m

c
u
s
t
o
m
e
r

e
q
u
i
t
y

(
$
)


.
GRG
Proposed model