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Comput Econ (2008) 32:317–339 DOI 10.

1007/s10614-008-9141-7

The Effects of Customer Value on Loyalty and Profits in a Dynamic Competitive Market
Ting-Hua Chang · Jun-Yen Lee · Ru-Hwa Chen

Accepted: 2 April 2008 / Published online: 26 April 2008 © Springer Science+Business Media, LLC. 2008

Abstract Providing high value products and services to customers normally leads to customer loyalty and profits. In practice, the relationship of customer value, loyalty, and profits can be observed in the market. However, the dynamic interactive relationships which lead to customer loyalty and profits still remain ambiguous. In this paper, the Agent-Based Computational Economics (ACE) model is introduced to explore the formation of customer loyalty in the Taiwanese imported lumber market. Using agents with reinforced learning algorithms in trading simulations, the effects of customer value on loyalty and profit are incorporated and examined in this interactive dynamic model. As results, the positive correlations among variables of customer value, loyalty, and profits are observed. A controlled experiment shows that changing customer value leads to changes in customer loyalty and profits, but price is not the determinant factor for improving customer loyalty. The R 2 values of customer loyalty and profits elucidate that they are increasing as the time lapsed elongate. Providing high value of products and services is a better strategy for suppliers to attract potential loyal customers. Keywords Agent-based computational economics (ACE) · Experimental economics · Business to business marketing · Interactive marketing JEL Classification C63 · C92 · L73 · M31

T.-H. Chang Department of Information Management, Ling Tung University, Taichung 408, Republic of China J.-Y. Lee (B ) · R.-H. Chen Department of Bio-industry and Agribusiness Administration, National ChiaYi University, ChiaYi 600, Taiwan, Republic of China e-mail: leejy@mail.ncyu.edu.tw

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1 Introduction To achieve higher profits, suppliers have committed tremendous efforts building customer loyalty by maintaining relationship quality and providing value for customers. Offering high value in products and services is fundamental for establishing a stable relationship that can eventually lead to more profits for the company. Customers, normally, adjudge a product or service as high or low value depending on the extent that it can satisfy their needs. For example, retail buyers favor suppliers who understand the vendors’ down-stream customers and provide merchandises that can be easily marketed to its shoppers. The result is higher value for retailers at no extra costs, which is critical when it comes to building loyalty. The correlation between customer value and loyalty has long been identified from prior literatures (e.g., Bolton and Drew 1991; Cronin et al. 2000; Sirdeshmukh et al. 2002). Previous researches consider how value drives customer behavior and loyalty in the traditional static data. However, the forming process of a trading network and the evolvement of customer loyalty in a dynamic interactive system still remain ambiguous. A case in point is how changes in customer value (e.g., price and quality) influence customer loyalty long-term. The Agent-Based Computational Economics (ACE) model is introduced to understand the dynamics of the interactive market processes and the emergent properties of the evolving market structures and outcomes. The ACE is a computational simulation specializing in modeling the economics of a basic complex adaptive systems paradigm (Holland 1992). It is a bottom-up culture-dish approach to the study of evolving economic systems using autonomous interacting agents (Tesfatsion 2002). Further investigation of ACE and other introductory materials can be found in Axelrod and Tesfatsion (2005); Batten (2000), and Epstein and Axtell (1996). The contribution and objectives of this paper are to understand the evolution of relationships between customer value, loyalty and profits, and to investigate the effects of customer value changes on loyalty and profits during the trading periods. Modeling the Taiwanese lumber market using the ACE model may possibly provide suggestions for managers to improve their customer value strategy in order to strengthen customer loyalty.

2 The ACE Model Framework for Lumber Market 2.1 The Taiwanese Lumber Market The trading behavior of Taiwanese lumber market is not complicated and functions as a typical value-loyalty market. Since 99% of raw lumber in Taiwan is imported from foreign countries, the trading behavior model can be simplified. Many factors, such as political, social & cultural network, family-owned business, supply-demand level, which may possibly influence lumber purchasing decisions, can be eliminated. Such a simple market allows us to focus on a few limited key variables and is ideal for studying the direct effects of customer value on customer loyalty. In this market, buyers (e.g., resellers and manufacturers) purchase imported lumber to resell to small OEM wood products manufacturers or to produce wood products

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Agents with their learning algorithms are the basis for eventdriven interactions between the players. If a supplier fails to provide good quality lumber at a reasonable price or fails to deliver on time. Each rule has a measure of its strength. the agent reacts. hardness/softness of wood. agents try actions. The probability a strategy can be selected is equivalent to its strength. Exploring new customers cost more than maintaining current customers in this globally competitive business-to-business (B2B) wood market. Roth and Erev 1995). See the Appendix B for the state diagrams of the agents. Each agent makes decisions by means of a classifier system which consists of a set of rules (Holland et al. An event can be an action an agent has performed. and on-time delivery. Classifier systems are a form of reinforcement learning which is based on two principles. Each agent has a set of uniquely defined states and state-transitions are triggered by events. customs regulation. and language barrier. Using state-driven programming. an action performed by other agent. The supply chain can only be sustained if the Taiwanese importers can easily sell to down-stream buyers. export taxes. Second. Central America. First. There are two types of strategies in any decision box: one 123 . actions leading to better outcomes in the past are more likely to be repeated in the future (Bush and Mosteller 1955. and service). Building enduring relationships with purchasers requires providing higher value from the customer’s viewpoint. Social networks. at a reasonable price. they prefer establishing long-term relationships with Taiwanese purchasers in order to generate greater profits and to keep cost down. Africa. written in C++. 2. Subsequently. will pick a strategy from each decision box. the buyer may switch because of his lost profits and customers. The code. each agent acts asynchronously and randomly in time. an agent. Since more than 99% of the 470 million M3 wood consumed annually in Taiwan is imported from areas such as North America. This means that oversea suppliers are all on a level playing field for Taiwanese lumber buyers when it comes to the hassle of cultural. Sutton 1992. and Southern Asia.2 The ACE Model Framework Our ACE model of customer value and loyalty heavily relies on the evolving incentive structure of the market. the impact from the domestic lumber suppliers can be negligible and eliminated from the model. and government regulations) and quality (which include goodwood ratio. or cultural factors are not included in the model because all the buyers are within one country and prefer suppliers who can provide a stable and consistent lumber quality. who has several decision boxes. This means good quality at a reasonable price which is frequently evaluated by the buyers.The Effects of Customer Value on Loyalty and Profits 319 such as furniture and cabinets directly. or things that happened in the environment. Depending on its current state and the events it receives. price (which include cost of lumber. From the suppliers’ point of views. Instead of choosing from all possibilities. uses classes as agents which represent companies. the Taiwanese lumber buyers choose suppliers mainly based on completion time (How soon can it be delivered?). direct personal relations. Reinforcement learning needs not to make many assumptions about the agents’ reasoning process and is considered the most elementary forms of learning. 1986). Our model uses a simplified version of the classifier system.

There are three agent classes in this three-tier trading hierarchical model: suppliers. The 40/10/10 ratio is close to real market firms distributions. The authors have discussed these stylized facts and identified the strategies in the strategy boxes with the actual Taiwanese buyers in order to reflect the real market situation more accurately. manufacturers are just buyers.-H. which is always true for a small market like Taiwan. The total demand for the entire lumber market per month in Taiwan is generated from a N(1000. The payoff of a strategy set for that month is the monthly profit of a firm. 1). Suppliers Resellers Manufacturers Fig. There are initially 40 lumber suppliers. the ACE is a mathematical model executing programs to solve its equations.320 T. and 10 manufacturers arbitrarily set in our model. resellers are not only sellers but buyers too. One unit of lumber corresponds to 1. The strategy collections might at first appear to be arbitrarily chosen.1 probability left.3 Supplier Agent A supplier agent merely behaves as seller. If this month’s profit is less than or equal to last month’s profit. It is a derived demand and determined by downstream users of the manufacturer agents. At the beginning of every calendar month. It has been shown that the precise values of the two probabilities have no importance to the statistical features of the results as long as one of them dominant. The collection of strategies from all decision boxes forms a strategy set. The lumber suppliers are merely sellers. but transoceanic shipments are slow. Interactions between agents occur every month. Chang et al. 1 The trading hierarchy of different types of agents dominant strategy and many test strategies. At the end of every calendar month. resellers. The outputs of an ACE computer program are not artifacts to be explained. One unit of price represents one thousand U. 2. In fact.000 cubic meters.9 and the many test strategies share the 0. the agent calculates his profit and compares it with last month’s profit. the closer the values the more statistics are needed for the simulation to reach the same significance level.S. The computer program itself is the model that explains the social facts. 10 resellers. and manufacturers (Fig. an agent picks a strategy set and records his selections in archives. 300) normal distribution. The total supply for the entire lumber market is assumed to be sufficient. The parameters used in this ACE model are summarized in Appendix A. dollars. He is the low-cost oversea lumber supplier for the Taiwanese lumber market. but they have pretty much covered most of the possible situations. however the conclusions are not altered. Each agent is 123 . If the profit of this month is higher than profit of last month and a different set of strategies was selected for this month. For other choices of pair of probabilities. then nothing happens. then this set of strategies becomes dominant and is assigned the dominant probability for the next iteration. The dominant strategy probability is set to 0.

The quality of lumber is dependent on sources of logs. each supplier gets a fixed amount of 50 lumber units from its timberland. and hence has a better chance of providing higher value to buyers. This strategy is used when a seller is trying to attract new customers. At the creation of each supplier. Since the elapse time from when a quote was given to a customer and the acceptance/rejection of that quote by the customer usually occurs within 24 h. This parameter determines the average percentage of good lumber produced by a supplier agent. the seller immediately notifies the buyer and then proceeds to the next order. The supplier checks his remaining stocks in the warehouse because he must have enough stock on hand for completing a successful deal and he may run into shortages if there are too many orders. we assume it to be a non-divisible unit and the supplier has to wait for the customer to respond before moving on to the next customer in the queue. This strategy may be used when a seller is trying to sell more to an old customer base. (iv) Small order priority: Smaller orders get higher priority for this month. he is randomly assigned a good-wood ratio from a normal distribution. and acceptance of a quote during the month. This may affect loyalty since a customer may want and value consistent supply from one vendor. If no requests for quotes come in for that month. In this case. requests for quotes from customers (in this case. A seller may use this strategy when he wants to get rid of inventory for short-term profits. The quote is then handled one at a time according to the processing priority. and perhaps cracked wood. and the drying and processing technology. usually classified as low grade lumber. there are five different strategies that a suppler can choose from in order to handle the queue: (i) Large customer priority: A buyer who bought more in the past gets early order processing. Wood that has some twists. If the stock is insufficient. checked. this strategy may be used when a seller is trying to serve the biggest customers first. the reseller agents and the manufacturer agents) during the month.The Effects of Customer Value on Loyalty and Profits 321 assigned a good-wood ratio. The five events a supplier agent responds to are as follows: beginning of each calendar month. then no actions are taken and the 50 units of wood are added to the supplier’s inventory. if there are several quote requests in that month. the customer’s rejection of a quote given during the month. and to simplify the ACE model. The value ranges from 50% to 99%. a supplier may have many requests for quotes. ending of each calendar month. (iii) Large order priority: Bigger orders get higher priority for this month. (v) First in first out: This accounts for arbitrary decisions that a seller may make. A poor and rough production line produces distorted. the exporter sends the selling 123 . each supplier needs to decide which quote needs to be processed first. and responds to 5 events in which 2 decisions have to be made for its decision set. Otherwise. So. twisted. (ii) Small customer priority: A buyer who bought less in the past gets early order processing. and distortions but is shipped out as high grade lumber due to low quality control causes buyers loss since the condition of the shipment is not known until several weeks later when it arrives in port. In this decision box. At the beginning of each calendar month. A firm with a higher good-wood ratio has better quality of lumber. Within a given month. checks.

(ii) Small customer discount: A customer among the lower half receives the discount price of 12.-H. 3. then the probabilities of strategies in all the decision boxes are changed according to Sect. a foreign supplier quotes the C&F or CIF price and it is paid by the buying firm. the supplier goes to the next order unchanged. A buyer has a probability of 0. is a function of quantity shipped. price per lumber unit to the buyer and waits for a respond before proceeding to the next quote request in the queue. This pricing strategy is used when a seller wants to served the biggest customers. otherwise the price is set to 15. This accounts for arbitrary decisions that a seller may make.2 to get the discount price of 12. the decision set stays the same. Each distributor has a warehouse capacity of 40 lumber units and buys lumber from the overseas suppliers if inventory is low.322 T. the other factor that is built into price. The customer immediately accepts or rejects the deal. If rejected. The shipping cost includes fixed cost (2 price units) and variable cost (0. Whether a customer accepts for rejects a quote depends heavily on price and quality. At the end of each period. Since 99% of lumber consumed in Taiwan are imported from overseas. If accepted. the monthly profit is calculated.5 off the normal price. and it can not close a month unless the sales 123 . otherwise receives the normal price of 15. This pricing strategy is used when a seller is trying to attract new customer. Since quality is randomly assigned to each supplier agent at its inception. A customer among the upper half receives the discount price 12. Ergo.2 price unit per one unit of lumber) per order. If a new strategy set was used in this month that resulted in a higher profit than the previous month. The purchasing department needs to know the amount sold to determine the amount that needs to be ordered. Chang et al. There are four strategies in this decision box: (i) Large customer discount: A customer is ranked.4 Local Reseller Agent/Intermediary/Distributor A local reseller has both buying and selling behaviors. The procedure is repeated until all orders in the queue have been processed or the ending of each calendar month event is sent. (iii) Discount according to number of purchases: Every two visits gets 0. They earn profit from selling lumber to local manufacturers. by the accumulated order amount. These local distributors complement the overseas lumber suppliers by providing fast delivery for urgent orders at a higher price. Shipping cost. the seller updates its inventory and its bank account. but the selling price is no less than 12. The selling price per lumber unit ranges from 12 to 15 depending on the suppliers’ selling price strategy. (iv) Random draw discount: The seller draws lots. according to his buying history. a reseller agent has two separate departments: a purchasing department and a sales department. otherwise he receives the normal price 15. This pricing strategy is used when a seller is trying to serve the frequent customers. 2. Otherwise. These two departments are interdependent.2. the only decision left for the lumber supplier is price: selling price and shipping cost.

we do not intend to create a model to fit all aspects of reality. a reseller can only order from one suppler at a time and this requires the distributor to prioritize the suppliers so he knows which supplier to try and purchase from first. Otherwise. can ask for quotes from multiple suppliers at the same time. 2. Thence.5 Reseller Agent: Purchasing Department Component The purchasing department of a reseller behaves as a buyer. then the reseller needs to order 20 lumber units for this month to meet the 75% warehouse capacity of 40 units. namely (i) fill 50% warehouse capacity. in reality. At the beginning of every month. Subsequently. The warehouse capacity intervals are arbitrarily set since these are usually a management decision in the business world. (ii) Seller’s wood quality according to its records: This strategy can ensure a stable quality of wood to avoid unexpected loss. To illustrate. the local reseller has to decide whether to accept the price offered or not according to the three strategies in this decision box: 123 . Otherwise. These intervals do not go below 50% because a reseller needs to carry an adequate supply in order to meet fast deliveries for urgent customers. If inventory meets the minimum level set by management. the purchasing department. then no actions are taken this month. and decides whether to buy some lumber or not. the decision set stays the same. and responding to a quote from an overseas supplier. Nonetheless. There are four strategies in this decision box: (i) Number of successful deals: Since suppliers often give discounts to faithful customers. (iv) Random: This may be a strategy use by a new buyer in the market. Once the intermediary verifies that more lumber is needed. then the probabilities of strategies in all the decision boxes are changed according to Sect. If a new strategy set was used in this month that resulted in a higher profit than the previous month. then the deal fails and the reseller moves on to the next supplier according to the queue determined by the previous decision box. The purchasing department responds to three events: beginning of each calendar month. If an “insufficient supply” message is sent to a reseller. and (iii) fill 100% warehouse capacity. The reseller agent chooses from three inventory management strategies.The Effects of Customer Value on Loyalty and Profits 323 department also concludes. (iii) Number of stocks available from seller: This strategy enhances the chance of getting supplies in time regardless of cost. the purchasing department checks the stocks remaining in the warehouse. (ii) fill 75% warehouse capacity. the reseller may get a lower price. At the end of each month. As long as the model can reproduce reasonable stylized fact. ending of each calendar month. a quote is sent to the buyer from the oversea supplier. A reseller then places the order and waits for a reply. the monthly profit is calculated from the spending of the purchasing department and the income of the sales department. it is a valid model. 3.2. if management chooses the 75% warehouse capacity strategy and only 10 lumber units remains in stock.

If the deal succeeds and the distributor sends an acceptance message to the supplier. the sales department responds to five events: beginning of each calendar month. This reflects the stylized fact that people are not willing to pay a higher price. The requests are handled one at a time. and acceptance of a quote during the month. transportation time and passing through custom). The tradeoff is higher cost. then its assets is updated.324 T. rejection of a quote during the month. If they know it is an inexpensive price. If there is not enough stock due to too many orders. then the purchasing department is finished for that month.-H. the sales departments always take the First-In-First-Out strategy when handling its customer queue. therefore. at the risk of having an empty warehouse. (ii) Comparable price: The firm accepts the offered price only if the price is no more expensive than the previous purchasing price. the number of times a reseller can order from a foreign firm during any given month is limited.0. ending of each calendar month. A buyer can only repeat this buying procedure at most three times or until the ending of each calendar month event is sent. The reason for such design is that an intermediary wants to sell his stocks as soon as possible so the liquidity can flow. When the offered price is 15. The distributor’s purchasing department is responsible for stocking the warehouse. if the offered price is 12. Unlike an oversea supplier. (i) Unconditional acceptance: The firm accepts the offered price unconditionally. Similarly. Requests for quote is limited to three times because completing an order from oversea is time consuming (i. (iii) Linear probability function: The offered price is accepted according to a linear probability function. A distributor must have enough stock available for completing a successful deal. This ensures that adequate supply is delivered quickly. then no actions are taken.7. the distributor immediately sends an “insufficient supply” message to the local buyer and proceeds to the next 123 . if there are several requests for quotes in that month. At the beginning of each month. If the purchase is made before the third time. requests for quote from customers (only from the manufacturer agents) during the month. 2. the probability of acceptance is 0. his inventory does not automatically increase by 50 lumber units. they will be less likely to accept the deal. the sales department checks the orders coming in for that month. the next supplier in the priority queue is then sent a request for a quote.e.. the imported lumber are inspected and the bad ones are abandoned according to the good-wood ratio from each supplier. they will be more likely to accept the deal. and at the risk of getting lower grade lumber. Chang et al. the probability of acceptance is 1. This strategy ensures the buyer a good price at the cost of spending more time trying to order from another supplier. Since a distributor does not own private timber land. If no orders come in for that month. If it is a premium price. The company checks the remaining stocks to see if the warehouse has enough supply.6 Reseller Agent: Sales Department Component The sales department of a reseller agent is a seller and operates similarly to a supplier agent with some exceptions. If the deal fails because the reseller declines.

or (iii) 50% full in the warehouse) but with a warehouse capacity of only 12 units. The manufacturer agent responds to three events: beginning of each calendar month. and orders from customers. The sales department repeats the procedure till the ending of the calendar month event is sent. The inventory management strategies a manufacturer can choose from are the same as the reseller’s purchasing department (i. However. At the beginning of every month. This is case where a seller is trying to take advantage of a desperate customer who doesn’t care about the price. This decision is not as simple as it seems.8. So. Its warehouse capacity is only 12 units. then the firm purchases more supply. the wood quality is guaranteed to be 100% good since all bad woods are abandoned prior to sell. (ii) Fixed profit margin: The unit profit is fixed at 4.e. 2. (ii) 75%.. there are three strategies in this decision box: (i) Fixed unit price: The unit selling price is fixed at 18.The Effects of Customer Value on Loyalty and Profits 325 inquiry. Otherwise a message with the selling price per lumber unit is sent to the buyer. if the company buys the wood at 18. The procedure of ordering raw supplies is similar but not the same as the reseller’s purchasing department. a manufacturer has the same 4 basic strategies and the possible interactions are explained as followed: (i) Number of successful deals: This is regardless of whether it is from an oversea supplier or a local reseller. A manufacturer can order from several supply sources and as many times as he needs in order to fulfill his customer’s demand for that month. and the seller waits for the buyer to respond. a buyer often considers price and since oversea suppliers 123 . Because a manufacturer can order from local resellers as well as oversea suppliers. the firm checks how many orders it receives from its customers and how much inventory is in storage. the interactions are more complicated. In order to make a successful deal. (i) 100%. These are the reasons a local reseller can compete with an oversea supplier and survive. To determine the firm’s selling price. with intercept equals to the average in-price and the slope is 0. This may be when a seller is looking for repeat sales. Although the unit selling price is higher than oversea suppliers. (iii) Linear probability function: The selling price is a linear-increasing function of previous month’s sale. then it will sell the product at 22. and the delivery is faster. but only one seller at a time. Nevertheless. If orders exceed what the company has in storage or if inventory is below the set level. Furthermore. this firm earns profits from selling wood products such as cabinet and furniture to exporters or household customers. a manufacturer can buy lumber from both oversea suppliers and local resellers. ending of each calendar month.7 Manufacturer Agent A manufacturer agent is just a buyer and is very similar to the reseller’s purchasing department. This makes sure the firm keeps its profits margin.

Meanwhile. This may be a strategy a high-end wood product manufacturer takes. the seller sends a quote. Customer demand for each manufacturer is generated randomly with the constrain of total demand for the entire market per month following the N(1000. However. (ii) comparable price. and the manufacturer needs to decide whether to accept or not. namely. and (iii) linear probability function. Otherwise. Once a manufacturer collects enough raw materials to produce the requested products. Since oversea suppliers and local resellers cannot complete an order unless they have all the stocks on hand. (iii) Number of stocks available from seller: This strategy can enhance the chance of getting the supplies in time. and the probabilities of strategies in the decision boxes are changed. At the end of every month. if needed. Standard economic rationality is rarely used to predetermine an agent’s actions such as how an oversea supplier treats loyal customers. 300) normal distribution. the firm processes its customer orders and the deal is done forthwith. the monthly profit is calculated. Examining this connection can justify the fitness of this model. The manufacturer continues these actions until all customer orders are completed or the end of month event is received. a big buyer will most likely buy from oversea suppliers. This may be a strategy for a manufacturer to take if a constant and steady stream of supply is critical to the business. the company continuously checks the remaining stocks to decide whether it wants to buy more lumber. This price decision box parallels the aforementioned price decision box for the reseller’s purchasing department. 3. A firm will keep choosing this strategy ONLY if profit from this strategy beats all other strategies. All wood products are sold at the unit price 20. One conventional perspective is the correlation between loyalty and customer value.-H. The order is then placed and the buyer waits for the seller to reply. (ii) Seller’s wood quality according to its records: This strategy can ensure stable quality to avoid unexpected loss. (i) unconditional acceptance. If the merchant sent an “insufficient lumber supply” message. however. An agent constantly adjusts its strategies based on learned experiences to survive environmental changes and to improve profit. (iv) Random: This may be a strategy use by new buyers in the market. Chang et al. if the buyer is always in urgent need because he sets his storage strategy too low. this is beyond the scope of this study so we simply assume an equilibrium price for all manufacturers.2. 3 The Assessment of the ACE Model The constructed ACE model simplified the characteristics of the real Taiwanese lumber market and the behaviors of individual agents. according to Sect. they have an advantage. The assessment of this ACE model is contingent on whether the outcomes of this simulation are consistent with the stylized facts of the real market.326 T. then it is more likely he will order from the resellers. then the company moves on to the next seller in its priority queue. often give discounts to faithful customers. The ACE model might have let a manufacturer set his selling prices freely and let its end-users choose. The representation of customer value 123 .

The positive correlations are consistent with 123 . and recommending the company to others (Prus and Brandt 1995). repeat purchases. however. and each point represents one simulation results from a randomly-chosen supplier firm. CVj is weakly correlated with Lj and P10j . For the business market. Selnes (1993). CV. There are 250 points in each scatter plot. loyalty (L). Monroe (1991) refers to value as the ratio between perceived benefit and perceived sacrifice by customers. In this study. Figure 2 shows the cross correlations between customer value. supplier j possesses an overall loyalty measurement from n buyers: Lj = n i =1 Lij n (2) Lj indicates the average loyalty from supplier j’s customers toward supplier j. purchasing different products or services from the same company. and the possibility of switching to other suppliers. Anderson et al. In this study. increase purchase volume. Woodruff (1997) finds that customer value is the difference between what a customer wants and believes what he gets while buying and using a seller’s product. total profit in 10-year (P10j ) is simply the total revenue minus the total cost of supplier j for a 10-years period in simulation time. loyalty of buyer i toward supplier j is defined as Lij = (number of times buyer i purchased from supplier j)/(total number of times buyer i purchased in the market). they still indicate definitely positive correlations. and P need to be defined and then mathematical representations need to be built. Second. one definition of CV is what the customer’s overall assessment of the utility of a product based on the perception of what is received and what is given (Zeithmal 1988). loyalty. technical. Lj correlates with P10j strongly. for instance. Customer Value of supplier j appraised by buyer i is defined as CVij = [(# of good units supplier j sold to buyer i)/(# of total units buyer i brought from supplier j)]/(average unit price buyer i purchased from supplier j). Last. L. indicates that loyalty includes the customer’s future repurchase willingness. supplier j’s average CV is CVj = n i =1 CVij n (1) CVj thus represents an average customer value of supplier j in the market. First. and total profit for a 10-years period in a simulated time frame. Gale (1994) indicates customer value is the market perceived quality adjusted for the relative price of the product. The value of R 2 is obtained by least square linear fit. and total profit (P) are defined and the cross correlation between them are checked in the following sections. Similarly. renewal contracts. taking into consideration the available suppliers’ offering and prices. For the n buyers who have brought from supplier j. service and social benefits received by a customer in exchange for the price paid for a product. To embody these concepts according to the Taiwanese lumber market. The significant tests on the slopes are shown in Table 1.The Effects of Customer Value on Loyalty and Profits 327 (CV). L can be identified from the reflection of customer behaviors. (1993) describe value as the perceived worth in monetary units of the set of economic. Though the slopes of the fittings are not steep.

0001 F 38.328 400 300 400 300 T. 1999. Loyalty Profit 200 100 R = 0. and profit for a 10-year period in simulation time frame Slope Loyalty vs. The errors are estimated by repeating the above procedure five times and take the standard deviation.7790 2 Loyalty Fig. The R 2 values of loyalty–profit correlations and slopes 123 . loyalty 0.0001 <0. Table 2 shows the profit and customer loyalty correlation coefficients and standard errors for the different time durations.134 0.039 0.779 field studies.223 3. respectively.067 0. Petrick et al. 2 Cross correlations between customer value. Cronin et al. 10. The running conditions are the same as in the previous section except for the running times. and 20 years. profit and customer value of a randomly-chosen supplier were recorded as one data entry point on the scatter plots. The running times for these plots are 5. One can see that this increasing trend is fairly stable and reproducible. 15. loyalty.1179 500 700 900 2 CV (Q/P) 400 300 CV (Q/P) Profit 200 100 0 0 50 100 150 R = 0. 2000. loyalty.1335 0 300 500 700 900 2 200 100 0 300 R = 0. CV Profit vs. and the slopes are obtained from plots in Fig. An ACE study of Marseille fish market (Kirman and Vriend 2001) also shows that loyalty and price dispersion can emerge as a result of the co-evolution of buyer and seller from market interactions alone.182 5. and Profit Since we have demonstrated that the ACE model can indeed produce results consistent with the real-world static observations. and profit for a 10-year period in simulation time frame Table 1 Significance tests of cross correlations between customer value. we may further explore what this model exhibits dynamically.011 0.217 33. Figure 3 shows the customer loyalty and the profit correlation for different time duration.128 Std error 0. 4 The Dynamic Relationships Between Customer Value. Choi et al. Chang et al. 2004). for each run.106 t -value 6.118 0. Loyalty. Chang and Wildt 1994. Each plot has 250 runs.0001 <0.08 R2 0.565 p -value <0. and have been explained in various qualitative models (Bolton and Drew 1991.757 29.139 874. CV Profit vs.-H. 3 via straight line fittings.

the probability of the L index fall within top ranks should increase.8035 0 50 100 150 200 2 R = 0. this model exhibits the character that to provide better customer value will bring in better profit for a firm in the long run. The suppliers firms with top 10% CV and last 10% CV were labeled to see what is the probability of the customer loyalty index of those firms will rank in top 10% Ls.3882 20-year 0. One can clearly see from Fig. CVs and customer loyalty index Ls of all supplier firms were ranked. Next we will exam the influence of customer value on customer loyalty formation process. If CV has a direct positive impact on customer loyalty. These results 123 . Note that the slopes divided by years of simulation gives the average profit per year for fixed loyalty.4552 0 50 100 150 2 R = 0.7790 200 2 Loyalty Fifteen-year duration 500 400 500 400 Loyalty Twenty-year duration Profit 200 100 0 Profit 300 300 200 100 0 0 R = 0.0093 0..1324 10-year 0.7183 0.8894 50 100 150 200 2 Loyalty Loyalty Fig. i. Together with the results concerning customer loyalty and profits relationship in last paragraph. while the firms with lowest 10% CV result in customer loyalty decreasing persistently.8878 0. one would expect that the customers will have a better chance to become loyal in the long run.3128 15-year 0.e. This indicates that building long-term loyal customers can indeed have positive effect on the company’s long-term profit.The Effects of Customer Value on Loyalty and Profits Five-year duration 500 400 500 400 329 Ten-year duration Profit 200 100 0 0 50 100 150 200 Profit 300 300 200 100 0 R = 0. 20 independent simulations were performed for different simulation time lengths ranging from 1 year to 20 years. For each simulation. 4 that the probability of getting better customer Loyalty increase steadily with time for firms with top 10% CV for 20 years.0093 0.9123 0.8355 0. In Fig.0367 0. The procedure was repeated five times for each simulation time period to calculate the probability. 4.4540 a Estimated by repeating 5-time and take the standard deviation divided by years of simulation increase as running time elongated.0228 0. 3 The correlation between loyalty and profit in different time durations Table 2 The correlation coefficients and standard errors of loyalty and profit in different time durations Durations Average R a R 2 standard errora Slope/year 5-year 0.

5. This type of experiment would be impossible in the real world because of the ever changing environment factors. 5 Changing of Customer Value on Loyalty: Quality or Price? Although there is a positive correlation between customer value and loyalty. these simulations were repeated 300 to 450 times. Everything else is kept to the normal condition. while keeping all other condition fixed. 4. In order to cover sufficient range of value space.-H. and/or reducing unit selling price. the changes in customer value should also be reflected in changes in loyalty.330 0.1 The Effects of Changes in Quality on Customer Loyalty To show the effects of changes in quality on customer loyalty. At the end of each 123 . and 15 for only one test supplier.5 0. Any results observed could have been the effects of many factors since these factors cannot be held constant. then management will want to increase customer value since it has a direct consequence on profit. all the data are collected from randomly-chosen firms and thus the correlations merely represent statistical results. 14.4 Probability 0. this does not sufficiently prove that an increase in customer value will correspond to a directly increase in customer loyalty. A test is needed to show whether an increase in customer value will correspondingly increase customer loyalty and the company’s profit. an increase in customer value can happened by either an increase in the ratio of good product (quality). 4 The evolution of customer loyalty affected by customer value are again consistent with field studies.6 Prob (the top 10% of L | the top 10% of CV) Prob (the top 10% of L | the last 10% of CV) T. Chang et al. From the definition of customer value in Eq. selling prices are held constant at 12. If this is shown to be true. and have been explained in various qualitative models. Each simulation lasted 10 years. it is important to do a control experiment. For example.2 0. ACE overcomes such difficulty. 1.3 0. Recall that in Sect. 13.1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Year Fig. The next two sections will depict the impacts of price or quality on customer loyalty. 0. In order to show these variables are not correlated via a third factor.

and profit of that test supplier were recorded as one data point entry. it merely shows that the ACE model is capable of studying such problem if the correct qualitycost relation is known and incorporated into the existing model. our model does not consider the extra cost for increasing quality. 6). the model predicts that price is not the determinant factor for improving customer loyalty and profits. Thus.7. an optimal CV which maximizes the profit might exist in the middle range. At present. These plots indicate that customer loyalty is not sensitive to price changes. quality is now held constant at 0. customer value can only increased through higher quality. 5 The relationship of customer value and loyalty. 5.1394 2 400 500 600 700 800 300 400 500 600 700 800 CV (Q/P) CV (Q/P) Fig. Since price is fixed for the test supplier. Furthermore. If it was incorporated in the model. In the same token. The R 2 values are much lower than those plots of fixed price settings in prior section. lumber buyFixed Price at 15 200 150 200 150 Fixed Price at 14 Loyalty Loyalty 2 100 50 0 300 100 50 0 300 R = 0.0802 R = 0. Figure 5 clearly shows that better quality of lumber leads to higher customer loyalty. CV.2 The Effects of Price Changes on Customer Loyalty To show the affect of price changes on customer loyalty. the simulations run for 10 years with each run being repeated 200–250 times depending on customer value’s phase space. 7 and 8). 0. However. This suggests that our ACE model can be used for scenario and for long-term strategic decisions. In practice. also the slopes are all near zero (Figs.6. Again. profits should also increase at the same time (Fig. Specifically.8. 0. market share can also be examined in relations to price and value. It is theorized that the customer loyalty will show the most improvement if lumber quality can be increase without increasing unit price.0862 R = 0. though the R 2 values are low. changes of quality at various unit price in 10-year period 123 . this relationship is especially true when the price is lowest at 12.The Effects of Customer Value on Loyalty and Profits 331 simulation.0738 2 400 500 600 700 800 400 500 600 700 800 CV (Q/P) Fixed Price at 13 200 150 200 150 CV (Q/P) Fixed Price at 12 Loyalty 100 50 0 300 Loyalty 2 100 50 0 R = 0.9 for one test supplier while everything else operates normally. and 0. loyalty.

profit drops especially in low quality products.005 0 300 400 500 600 700 0 300 400 500 600 700 CV (Q/P) 150 CV (Q/P) Fixed quality at 0. 7 The relationship of customer value and loyalty. 8. changes of quality at various unit price in 10-year period Fixed quality at 0. this reflects to higher value in those plots.0022 50 2 Loyalty 100 100 50 R2 = 0. 6 The relationship of customer value and profit. Similar tests were done to study the effect of customer value on 10-year profit. Chang et al. As the selling price is reduced.7 150 100 100 Loyalty Loyalty 50 50 R2 = 0.1512 2 400 500 600 700 800 0 300 400 500 600 700 800 CV (Q/P) CV (Q/P) Fig. changes of price at various fixed quality in 10-year period ers are more concerned about lumber quality than price.-H.111 100 0 300 100 0 300 2 R = 0. This is understandable since 123 .6 Fixed quality at 0.9 150 150 Fixed quality at 0. poor quality lumber tends to ruin the long-term relationship with downstream buyers.0081 R = 0. Unit Price=14 Profit 200 Profit 200 R = 0. as shown in Fig.0003 2 0 300 400 500 600 700 0 300 400 500 600 700 CV (Q/P) CV (Q/P) Fig.332 Unit Price=15 400 300 400 300 T. In fact.8 Loyalty R = 0.1184 100 0 300 100 2 R = 0.0823 2 400 500 600 700 800 400 500 600 700 800 CV (Q/P) Unit P rice=13 400 400 CV (Q/P) Unit Price=12 300 300 Profit Profit 200 200 R = 0.

6 300 300 Profit Profit R = 0. since our model does not include the cost for improving quality. changes of price at various fixed quality in 10-year period unit selling price drops. This is especially evident when quality increase without price increasing.015 2 200 200 100 100 0 300 R = 0. The model also depicts that higher loyalty is tied to higher long-term profits. Evidently.0718 2 0 300 400 500 600 700 400 500 600 700 CV (Q/P) CV (Q/P) Fig. Notwithstanding.0099 2 0 300 400 500 600 700 0 300 400 500 600 700 CV (Q/P) Fixed quality at 0.The Effects of Customer Value on Loyalty and Profits Fixed quality at 0. and thus results in lower total revenue. 8 The relationship of customer value and profit. The highest profit is achieved in the quality = 0. this paper shows that customer value alone is sufficient to explain loyalty emergence. Changes in prices on customer loyalty and profits are not obvious. But this phenomena is not observed in the quality = 0.9 400 400 333 Fixed quality at 0. The model also shows that the evolution of customer loyalty is affected by the customer value as time elongated. and have limited cognitive capabilities. 6 Concluding Remarks This paper uses ACE to model a simplified Taiwanese wood market. Each supplier simply adjusts strategies through reinforcement learning in order to improve profit based upon past experiences. one should not attempt to conclude that to provide best quality products will maximize the profits. but it is unattractive for total sales of low quality products to lower price.002 100 2 100 R = 0. All agents in the model have no sophisticated reasoning.9 setting. This may suggest that total sales for high quality lumber can be enhanced by reducing price.8 300 300 Profit Profit 200 200 R = 0. 123 . the simulation finds that providing high customer value is an effective strategy for suppliers to attract potential loyal customers.7 400 400 CV (Q/P) Fixed quality at 0. one cannot say that all other additional psychological factors do not play a role in reality. However. The model does not include social network. In summary. or cultural factors to reproduce the loyalty and customer value correlation.9 setting. direct personal relations.

Appendix A: Parameters Used in the Model Global parameters • Random number seed • Modified RL: The dominant strategy probability • Number of suppliers • Number of resellers • Number of manufacturers • The total demand of the market per month Using standard clock value as seed.334 T.99 • At the beginning of each calendar month.9 40 10 10 N(1000.2 price unit per one unit of lumber) per order Buyers • Number of orders per month before 3 timeout • Reseller warehouse capacity 40 • Manufacturer warehouse capacity 12 • For a Manufacturer.5–0. all wood products are sold at the unit price 20.-H. 300) Suppliers • The selling price range per lumber unit 12–15 • Good quality wood ratio 0. each supplier gets a fixed amount of 50 lumber units from its timberland. 0. Chang et al. • The shipping cost includes fixed cost (2 price units) and variable cost (0. No warehouse capacity limit. 123 .

The Effects of Customer Value on Loyalty and Profits 335 Appendix B: State Diagram of Agents Get supply Update stock Suppliers Flow Chart Wait for order Post available stock Check mailbox no Got order? done yes Survey buying order done Determine buying queue yes Process top order no Order queue empty? Read top order Top order finish Check stock Determine sell price yes Enough stock? no Reply to buyer Dump top order Reply to buyer Wait response Buyer reply update no yes Price accepted? Response received Deal made 123 .

336 T. Appendix B continued Post stock info Wait for order Check mailbox no Dump top order Got buy order? Done yes Finish processing Process buy order Reseller seller Flow Chart no Reply to buyer Have enough stock? yes Stock sufficient Post sell price Reply to buyer Wait for response Buyer reply update Response received yes Deal made Price accepted? no 123 .-H. Chang et al.

The Effects of Customer Value on Loyalty and Profits 337 Appendix B continued Check stock Buy some stock? yes Time out? yes no Ordering stocks How many? From whom? no done Place buying order Reseller buyer Flow Chart Wait for response Supplier reply Response received Read response no Supplier have stock? yes Reply to seller no Accept price? yes Reply to seller Deal made Dump bad wood and update Finish ordering 123 .

Appendix B continued Check waiting queue done no yes Time out? Begin ordering Finish processing no Got order? yes Check stock Order stock? update Process order Manufacturers Flow Chart From whom? How many? sell Check stock Place buying order Stock sufficient yes Enough stock? no Wait for response Stock in need Seller reply yes Time out? no Order from whom? Finish processing done Response received Finish processing Place buying order update Read response Wait for response no Having stock? Seller reply no Response received Reply to seller Accept price? Read response no yes Having stock? yes update no Reply to seller Accept price? yes Reply to seller Deal made Enough stock? sell Reply to seller no Stock sufficient Deal made Dump bad wood Finish ordering Dump bad wood and update 123 .-H. Chang et al.338 T.

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