The Service Industries Journal, 2014

Vol. 34, No. 2, 103 –122, http://dx.doi.org/10.1080/02642069.2013.763929

Using customer lifetime value to plan optimal promotions

Yeliz Ekincia∗ b, Füsun Ulengina and Nimet Urayb,c
a
Industrial Engineering, Dogus University, Istanbul, Turkey; bInstitute of Science and Technology,
Istanbul Technical University, Istanbul, Turkey; cEngineering Management, Istanbul Technical
University, Istanbul, Turkey
(Received 14 July 2011; final version received 7 April 2012)

The purpose of this study is to develop a methodology to guide managers in

determining the optimal promotion campaigns to be directed towards different
market segments in order to maximize the value of customers. For the purposes of
this study, a two-step methodology is used, based on stochastic dynamic
programming and the classification and regression tree. This methodology groups
the customers according to their value. Within this framework, an experiment is
conducted in which each of the different promotion campaigns is assigned to
different randomly selected groups. The impact of each type of promotion on each
type of market segment is analysed in order to find the optimal promotion
campaigns appropriate for each. In contrast to previous research, this study takes
into account a firm that provides more than one specific type of product or service.
In addition, it analyses the impact of widely used types of promotion campaigns
compared with the narrow scope of those investigated in previous studies. Therefore,
this research presents important insights into managing relations with the customers
in a more interactive and profitable way.

Keywords: customer lifetime value; optimal promotion; profit maximization

Introduction
Recent empirical studies, both on service marketing and decision making, mostly focus on
developing quantitative tools for managing customers more effectively (Khajvand,
Zolfaghar, Ashoori, & Alizadeh, 2011; Pfeifer & Ovchinnikov, 2011; Yi Wen & Ku,
2010). This study is another attempt to accomplish that objective. The main aim of the
paper is to determine an optimal promotion strategy for the customers of a service
company that provides more than one specific type of product or service. Undoubtedly,
today corporate success depends on an organization’s ability to build and maintain relation-
ships with loyal and valued customers. Therefore it is necessary to build strategies for cus-
tomers based on their value (Kim, Jung, Suh, & Hwang, 2006). One tool for identifying
the value of customers is the measurement of customer lifetime value (CLV). CLV is
defined as the present value of all future profits obtained from a customer over the time of
that customer’s relationship with a firm (Bechwati & Eshghi, 2005; Gupta et al., 2006;
Pfeifer, Haskins, & Conroy, 2005). In other words, the value that a customer brings to the
firm is not limited to the profit obtained from each of his/her transactions, but is, rather,
the total profit s/he may provide over the duration of his/her relationship with the firm
(Kumar & George, 2007).

∗
Corresponding author. Email: ekinciyeliz@yahoo.com

# 2013 Taylor & Francis

104 Y. Ekinci et al.

Since the emergence of relationship marketing and the growing importance of custo-
mer relationship management (CRM), there has been an increase of interest in CLV (Dibb
& Meadows, 2001; Ryals & Knox, 2005). The literature on CLV consists of two groups of
studies. The first group focuses on different tools to measure CLV, while the second aims
to maximize it (Kumar & George, 2007; Kumar & Rajan, 2009). Although former research
in the literature has especially concentrated on the first group, recent research aiming to
find out methods to maximize CLV is rather limited. Thus, one contribution of this
study is to enhance the boundaries of the knowledge derived from the second group of
studies. On the other hand, CLV applications developed so far (see Table 1 given in the
second section) focus on offering mainly one type of product or service, while this
study provides the possibility of investigating the impact of promotion campaigns in a
company having a wide range of product portfolios. Furthermore, previous studies gener-
ally analysed the impact of a narrow range of promotion campaigns such as sending mail,
providing price discount or offering loyalty cards. However, this study considers the pro-
motion campaigns in a wider perspective, taking into account different types of campaigns
based on the frequency of their usage in practice.
One very important point about CLV analysis is that customers may differ sub-
stantially across industries, and such differences should be reflected in the models
used to evaluate them (Haenlein, Kaplan, & Beeser, 2007). Therefore, the calculation
of CLV has to be industry-specific rather than general (Gurau & Ranchhod, 2002; Jain
& Singh, 2002). On the other hand, not all customers are equally valuable. Therefore,
it may be desirable to allocate different resources to different groups of customers
(Gupta et al., 2006). The CLV measurement provides valuable information for estab-
lishing appropriate strategies for different customer segments, such as those who are
key customers, more costly, purchase on a regular basis, and those whom the firm

Table 1. Literature survey.

Methodology
Bayesian approaches
(pareto-NBD,
Stochastic hierarchical Bayes
dynamic approach, Bayesian Genetic
Author-year programming decision-theory) algorithm Application area
∗
Ching, Ng, Wong, Advertising and
and Altman promotion
(2004) decision
∗ ∗
Jonker, Piersma, and Optimal mailing
Van den Poel policy
(2004)
∗
Venkatesan, Kumar, Customer selection
and Bohling for marketing
(2007) actions
∗
Labbi and Berrospi Optimal promotion
(2007) strategy
∗
Ho, Park, and Zhou Optimal investment
(2006) for CLV
∗
Piersma and Jonker Mailing frequency
(2004) problem
Note: ∗ denotes that the study uses the methodology; NBD, negative binomial distribution.
 The Service Industries Journal 105

would be better off not serving (Gummesson, 2004; Ryals & Knox, 2005). Using the
CLV to guide marketing decisions not only encourages companies to recognize
differences between customers but also to create value through differential treatment
(Pfeifer & Ovchinnikov, 2011).
CLV measurement is possible in companies that maintain databases of customer/
end-user information on a substantial percentage of customers and that can customize
marketing ‘investments’, at least to some extent, across customers. Such companies
include hotels, airlines, credit-card companies, banks and financial service providers,
companies that sell over the Internet, telecommunications companies, cataloguers,
retail stores with ‘loyalty’ or ‘frequent shopper’ programmes, publishers, computer com-
panies that sell directly to consumers, and many more (Malthouse & Blattberg, 2005). In
fact nowadays, even smaller shops/restaurants are implementing various kinds of CRM
initiatives using the information about their customers. Companies that maintain data-
bases of customer/end-user information are able to keep extensive data on the personal
characteristics and purchasing behaviour of their customers. The advantage of this situ-
ation is that the company can derive information about consumer behaviour and plan its
marketing strategies accordingly (Yi Wen & Ku, 2010). By using customer information
contained in databases, companies can invest in customers who are (potentially) valu-
able to the company while trying to minimize their investment in non-valuable custo-
mers (Mulhern, 1999).
This study proposes a methodology to select customers according to the value that they
generate, and to specify which type of promotions should be allocated to which customers
in order to maximize the company’s overall value. The first section of this paper presents a
literature review on the CLV applications to marketing decisions in general, and to pro-
motion campaigns in particular. In the second section, the proposed model is explained.
The third section gives information about the application of the model and presents empiri-
cal results. The last section closes the paper with conclusions and suggestions for further
research.

The use of CLV applications in marketing: the state of the art

In recent years, CLV has been accepted as a reliable tool for guiding managers of organ-
izations in their CRM decisions. Undoubtedly, managers considering a CRM strategy have
to ponder and evaluate whether this effort is worth the cost. CLV analysis provides the
answer to this question. CLV provides a performance criterion for measuring the
success of CRM actions directed towards customers. Since the main idea behind CRM
is the assumption that customers differ in their needs and in the value that they generate
for the firm, the way customers are managed should reflect these differences. This leads
to the conclusion that CRM is not about offering the best possible service to every
single customer, but about treating customers differently depending on their CLV
(Haenlein et al., 2007).
Calculation of CLV for all the customers helps the firms to rank the customers on the
basis of their contribution to the firm’s profits (Kumar & Reinartz, 2006). This can provide
a way to formulate and implement customer-specific strategies in order to maximize their
lifetime values (Kumar, 2006). The method of maximizing CLV is discussed widely in the
literature. As is also stated by Kumar and George (2007), CLV is maximized by imple-
menting customer-level strategies such as optimal resource allocation, purchase sequence
analysis and balancing acquisition and retention spending. CLV analysis suggests that the
value of a relationship with a customer can be increased either by increasing the amount of
106 Y. Ekinci et al.

profit gained through the customer or by extending the lifetime of the relationship
(Guillén, Nielsen, Scheike, and Pérez-Marı́n, 2012; Ryals & Knox, 2005). For this
reason, different relationship-marketing strategies are suggested for customers at different
stages of their lifetime.
Most studies about the use of CLV for marketing decisions have been focused on the
question of allocation of resources for marketing mix elements, together with its impact on
the CLVs of customers (Berger et al., 2002; Donkers & Verhoef, 2001; Kumar, Ramani, &
Bohling, 2004; Ryals & Knox, 2005).

Resource allocation for elements of the marketing mix

In reality, there is a continuous interaction between CLV and resource allocation. The
resource allocation is made based on CLV, but the marketing activities conducted as a
result of this resource allocation will influence, in their turn, the CLV of each customer.
Berger et al. (2002) stated that firms must take four actions in order to understand how
their marketing activities affect the value of their customer assets: (1) Create a database
to guide the collection of marketing intelligence for the calculation of CLV; (2)
Segment customers according to their needs and purchasing behaviour, taking into
account such factors as their purchasing power, the regularity of their purchasing, and
the type of products they purchase; (3) Forecast CLV under alternative scenarios; (4)
Allocate resources to maximize the value of the customer base.
Marketing-mix decisions involve the allocation of marketing budgets across customers
or market segments. The optimal allocation strategy evaluates customers based on their
CLV and recommends appropriate marketing initiatives that need to be taken (Kumar
& Rajan, 2009). The study of Kumar, Venkatesan, Bohling, and Beckmann (2008) is a
typical example of such studies. It presents a case study of how IBM used CLV as an indi-
cator of customer profitability and allocated marketing resources based on CLV. CLV was
used as a criterion to determine the type of marketing communication through direct mail,
telesales, e-mail, and catalogues for each customer. Similarly, Kumar (2010) segments the
customers based on the value they provide to the company, and advocates sending targeted
messages using differentiated modes of communication. When a valid measure is avail-
able, resource allocations can be made in a manner that maximizes the return on the mar-
keting investment (Mulhern, 1999). The studies of resource allocation for marketing
actions can be classified as those of more than one action and those concentrating on
only one action (e.g. mailing policy).

Determination of optimal promotion strategy: state of the art

Determination of the optimal promotion strategy includes making a decision about the
marketing actions that are to be offered to each customer. In the literature, two specifically
different tools are used for this purpose: stochastic dynamic programming and Bayesian
decision-theory.

Stochastic dynamic programming-based model

Stochastic dynamic programming (i.e. Markov decision process) and Markov chains have
a long history in CLV studies (Morrison, Chen, Karpis, & Britney, 1982; Pfeifer &
Carraway, 2000; Rust, Lemon, & Zeithaml, 2004). In stochastic dynamic programming,
at each time step, the process is in a state s, and the decision maker can choose any
 The Service Industries Journal 107

action a that is available in that state. In stochastic dynamic programming terminology, a

state is a specific kind of situation (for example, in the case of a machine replacement
problem, the states can be new, requires maintenance, or out of order). Detailed infor-
mation about the stochastic dynamic programming can be found in many sources (see
Ross, 1983).
Although there are a considerable number of studies using a stochastic dynamic pro-
gramming model to measure CLV, the assumptions and the methodology are different
from one study to other. For instance, in the study of Ching et al. (2004), a stochastic
dynamic programming model was used to maximize the CLV under the assumption of
an optimal promotion strategy. The CLV of the customers was calculated for three differ-
ent scenarios: (1) Infinite horizon without constraints (without any limit on the number of
promotions); (2) Finite horizon (with a limited number of promotions); (3) Infinite horizon
with constraints (with a limited number of promotions).
A similar model was developed by Labbi and Berrospi (2007). These authors proposed
a three-step methodology (customer segmentation, customer dynamics, and portfolio
optimization) to determine CLV by means of dynamic programming algorithms in
order to identify which marketing actions are the most effective in improving customer
loyalty and increasing present value.
While the stochastic dynamic programming-based model makes an optimization by
maximizing CLV, the Bayesian decision-theory-based model finds the optimal promotions
based on Bayesian rules and probabilities.

Bayesian decision-theory-based model

The study of Venkatesan et al. (2007) as a typical example of the use of the Bayesian
decision-based theory model in the literature proposed a Bayesian decision-theory-based
customer selection framework that accommodates the uncertainty inherent in predicting
customer behaviour. They developed a joint model of purchase timing and quantity that
is suitable for selecting customers using CLV. Their study found that given a budget
constraint, customers that were selected by means of such a Bayesian decision-theory-
based framework (i.e. using the maximized expected CLV of a customer and the correspond-
ing optimal marketing costs as an estimate of future costs) provided the highest value.
Previous studies have concentrated on optimal promotion strategies for companies
that offer only one type of product or service (e.g. Internet usage (Ching et al., 2004)
or air tickets (Labbi & Berrospi, 2007)). Therefore, these studies used recency –
frequency – monetary values to define states. However, these variables may not be
effective for companies offering more than one type of product or service. The
recency value represents the date of the customer’s last purchase, the frequency
value is the number of purchases by a customer in a given time period, and the mon-
etary value is the amount of money spent by the customer in that period (Borle, Singh,
& Jain, 2008; Khajvand et al., 2011). When there is more than one type of product or
service, there exist many recency, frequency, and monetary values, and this makes it
difficult to apply the models previously used.
Following the above explanations, one can define the states s and s′ as the segments in
which the customer stays at a specific time period and the actions a as the promotional
campaigns offered by the decision maker (company) to the customer. The corresponding
reward Ra(s, s′ ) resulting from moving into the new state s′ can also be defined as the value
of this new segment. The transition probabilities between states under different actions
Pa(s, s′ ) can be defined by the probability of moving from segment s to segment s′
108 Y. Ekinci et al.

under promotional campaign a. According to these definitions, the stochastic dynamic

programming approach is found to be the most appropriate methodology for the problem
of finding an optimal promotion plan with the objective of maximizing CLV.

Effectiveness of relationship-based promotion activities

Jonker et al. (2004) presented a joint optimization approach addressing two issues: (1)
Segmentation of customers into homogeneous groups of customers; (2) Determination
of the optimal policy (i.e. what action to take from a set of available actions) towards
each segment. They implemented their joint optimization framework in the setting of a
direct mail operation for a charitable organization. Recency – frequency – monetary vari-
ables were used to segment customers. In a second step, Jonker et al. determined which
marketing policy was optimal using Markov decision processes, following similar pre-
vious applications. The attractiveness of this stochastic dynamic programming procedure
is based on the long-run maximization of customer value. Finally, in a third step, they
looked for an alternative segmentation. Various (local) search techniques, such as
genetic algorithms, were used to determine new segmentations. The procedure then
returned to the second step and investigated the value of the alternative segmentation.
This iterative search process was stopped when an optimal solution was found. The con-
tribution of this study lies in the combination of these two steps into one optimization
framework to obtain an optimal allocation of marketing expenditure.
Piersma and Jonker (2004) also studied the mailing frequency problem, which
addresses the issue of how often to send a mailing to an individual customer in order to
establish a valuable long-term relationship, rather than targeting profitable groups of cus-
tomers at every new mailing instance. Sending a mailing to all customers is not usually a
preferred strategy. In this study, each state of the Markov model was used as a segment of
the customers in the database. The study decided on the number of mailings to send to each
customer over a given time period t (say, a year) in order to maximize the long-term
values. The mailing frequency problem for each individual was modelled as a Markov
decision process with the objective of maximizing customer value over an infinite time
horizon.
These types of studies were aimed solely to find the optimum level of one type of mar-
keting activity that should be directed to the customers of companies which offer only one
type of product or service. However, the companies operating in different industries in
practice, plan diverse marketing actions to take advantage over their competitors in the
market.
As can be seen from Table 1, stochastic dynamic programming is the most widely used
technique for the determination of optimal marketing actions in general. On the other
hand, previous studies have specifically concentrated on the optimal promotion strategy
for companies that offer only one type of product or service, and some of them have con-
centrated on only one type of marketing action, such as mailing to consumers. Therefore,
these studies used recency – frequency – monetary values to define states. However, as
stated earlier, these values may not be efficient for companies offering more than one
type of product or service. As can be seen from the literature review, the impact of
limited types of promotion campaigns, such as sending mails, providing price discounts
or offering a loyalty card, was generally analysed. However, the proposed model given
in the next section considers the promotion campaigns from a much wider perspective,
taking into consideration different types of promotion campaigns such as campaigns
 The Service Industries Journal 109

related to different products, namely investment products, credits, and credit cards for the
banking industry.

Proposed model
The approach of finding an optimal promotion plan with the objective of maximizing CLV
is still rare, since previous studies have generally determined states via recency –
frequency – monetary variables, and only one type of service has been considered in the
application of these studies. A flowchart of the proposed procedure is shown in Figure 1.
Step 1. Classification and regression tree (CART) is a statistical procedure that was
introduced by Breiman, Friedman, Stone, and Olshen (1984). It is primarily used as a
classification tool, where the objective is to classify objects into two or more populations.
It is also a useful technique when the aim is to partition cases into homogeneous groups
according to a target value (in this study, customer value). CART is a non-parametric
decision-tree-learning technique that produces either classification or regression trees,
based on whether the dependent variable is categorical or numeric, respectively (Lee,
Chiu, Chou, & Li, 2006). The CART procedure partitions data into terminal nodes by a
sequence of binary splits, starting at a parent node. It starts by executing a partition of
an initial training data set into two subsets, so that the cases in each subset are more
homogeneous than they are in the single set of the whole group (Bevilacqua, Braglia, &
Montanari, 2003).
One noticeable advantage of decision tree-based models such as CART is that these
models are scalable to large problems (Razi & Athappilly, 2005). Thus, in this study,

Figure 1. Flowchart of the proposed model.

110 Y. Ekinci et al.

we chose to define the states on the basis of the nodes resulting from CART, similarly to
the study by Haenlein et al. (2007). The states were the homogenous groups generated by
the tree. For the purpose of this study, several customer value drivers were used as predic-
tor variables, with the customer value being the target variable. The customer value was
defined as the revenue resulting from the transactions of customers minus the related
costs. The mean values of the states were then found, in order to be used in the other
steps of the procedure.
Step 2. The customers move between states according to a first-order Markov
process. A first-order Markov process is a stochastic process in which the probability
of a transition between two states depends only on the properties of the immediately
preceding state, independently of the path by which this state was reached. This con-
dition is referred to as the Markov property. Markov decision processes are widely
used in CLV studies (Morrison et al., 1982; Pfeifer & Carraway, 2000; Rust et al.,
2004). To estimate the transition probabilities, the states that the customers were in
at the beginning and at the end of each period were determined by using decision
rules obtained from the aforementioned CART analysis. Using this information and
also information about the promotional campaigns that were offered to customers in
each period, the transition probabilities between different states were found. Transition
probabilities are elements of Markov chains. A Markov chain model is characterized by
an N × N transition matrix P, where Pij (i, j ¼ 0, 1, 2,. . ., N 2 1) is the transition prob-
ability that a customer will move to state j in the next period given that currently the
customer is in state i (the retention probability of a customer in state i (i ¼ 0, 1, . . . ,
N 2 1) is given by Pii) (Ching et al., 2004). The transition probabilities in this step
were calculated from the formula:
Pij(k) ¼ (number of customers transiting from state i to state j under promotion cam-
paign k) / (number of customers in state i that are offered promotion campaign k).
Step 3. In this step, first the discount factors were selected, then the costs of the market-
ing promotion campaigns were derived, and finally the problem was modelled as a sto-
chastic dynamic programming model (i.e. a Markov decision process) that maximized
the present value for each state.
In this study, the problem was solved with the assumption of an infinite horizon. In a
Markov decision process, the optimal values vi satisfy the following (Ching et al., 2004;
Ross, 1983) for each state i and for j ¼ 1, . . . , M:

 

N −1
vi ≥ max c(j)
i +a p(j)
ik vk ,
j=1,...,M
k=0

where vi is the total expected value for a customer in state i, M is the total number of
marketing promotion campaigns ( j ¼ 1, . . ., M), dj is the cost of marketing promotion
campaign j in each period, pik( j) is the transition probability for the customer to move
from state i to state k with the jth marketing promotion campaign in each period, ci is
the mean customer value of state i, and a is the discount rate.
The solution to the problem gives the maximum expected present value for customers
in each state, together with the optimal promotion plan.
Step 4. The state values and the total value of the promotion campaigns were compared
with the status quo. The comparison was made according to the present values obtained for
each state, and appropriate promotion strategies were developed for each state.
 The Service Industries Journal 111

The use of the proposed framework in the context of banking industries:

preliminary data analysis
In order to test the applicability of the proposed framework, a Turkish bank was selected as
a case study. The basic reason for focusing on promotion campaigns was that these are
among the controllable factors that have the most considerable share in the marketing
budget. Furthermore, as Kumar and George (2007) state, knowledge about the impact
of these types of controllable factors will help to improve their performances. For this
purpose, an experiment was designed in order to observe the effects of promotions on cus-
tomers. Four representative samples, each containing 2500 customers, were derived from
the customer database, and four different promotions were directed towards those custo-
mers for a period of six months. In fact, the study covered a period of one year, but the
promotion campaign was applied for only six months. As a result, it was possible to evalu-
ate the situation before and after the experiment as well.
The product ownerships, the total value of the products, and information on customer
activity were obtained directly from the database; other predictor variables, such as the
profit per customer for each product type and the overall profit, were calculated using
the CART classification. For example, profits were calculated by a simple summation,
and behaviour scores were calculated using data-mining techniques such as logistic
regression, chi-squared automatic interaction detector, and CART. Owing to its low
level of reliability, demographic data was not included in the data set.
Step 1. The CART model partitioned the customers of the bank (all customers, not only
the ones in the experiment data set) into 29 groups based on three variables. The high
number of groups means that there are important differences among customers.
A summary is given in Tables 2 and 3. The R2 value of the tree was found to be 0.97,
which is very close to 1.00 and hence denotes high performance of the CART classifi-
cation. This shows that the predictor variables explain the target variable significantly.
Table 2 includes only the first six nodes (in order to be concise, but the entire table,
which includes 56 nodes, can be provided by the corresponding author), the means, and
the standard deviations, together with the number of records included in each node and
their percentages. Three numerical variables (V1, V2, and V3), which denote the monetary
values of different types of products owned by the customers, were used to split the nodes.
V1 is the profit value obtained from the customer’s assets, V2 is the profit value obtained
from the services that the customer uses, and V3 is the profit value obtained from the liabil-
ities of the customer. These variables include many types of products and services and
were generated by taking the total profits.
In node 0 in Table 2, all records are included, and their mean value is $10.457. Node 0
is divided into two nodes according to the profits obtained from the customers’ assets.
Those having V1 less than or equal to $23.105 are assigned to node 1, and the others to
node 2. Node 1 is divided into two child nodes based on the profits obtained from the cus-
tomers’ services, and node 2 is divided into two child nodes based on the profits obtained
from the customers’ assets. This procedure continues with the same logic and, at the end of
the process, 29 final nodes are formed. There are 1134 customers in the most valuable
node, 1109 in the second, 1378 in the third and 156,500 in the least valuable node,
which means that this node is very populous and should be of interest.
Table 3 includes the final nodes which were taken as the states for our proposed meth-
odology, and their mean values were taken as their expected values. Therefore, in the
model, there were 29 states, namely the final nodes; these states were numbered from 1
to 29, from the least valuable node (i.e. the final node with the lowest mean value, node
31, with a value of $1.416) to the most valuable node (node 56, with a value of $91.221).
 112
Table 2. A sample of the CART results: first six nodes.
Primary independent variable

Y. Ekinci et al.
Node Mean SD Number of customers in the cluster % Predicted mean Parent node Variable Improvement Split values
0 10.457 17.860 231,343 1 10.457
1 5.738 11.483 201,320 0.9 5.738 0 V1 149.327 ≤23.105
2 42.100 20.567 30,023 0.1 42.100 0 V1 149.327 .23.105
3 4.201 7.127 194,597 0.8 4.201 1 V2 59.517 ≤24.535
4 50.231 20.750 6723 0 50.231 1 V2 59.517 .24.535
5 33.340 12.795 21,708 0.1 33.340 2 V1 26.004 ≤50.595
6 64.972 19.403 8315 0 64.972 2 V1 26.004 .50.595
Table 3. CART table: final nodes.
Primary independent variable
Node Mean SD Number of customers in the cluster % Predicted mean Parent node Variable Improvement Split values
1 47.052 8.897 1659 0 47.052 9 V2 0.851 .37.505
2 62.891 9.377 1177 0 62.891 10 V2 0.907 ≤69.505
3 43.501 24.819 58 0 43.501 11 V2 0.368 .24.645
4 1.416 2.565 156,500 0.7 1.416 15 V3 4.350 ≤22.905
5 50.370 21.788 421 0 50.370 15 V3 4.350 .22.905
6 11.636 6.495 6700 0 11.636 16 V2 0.868 ≤13.365

The Service Industries Journal

7 20.632 6.380 3942 0 20.632 16 V2 0.868 .13.365
8 11.975 4.529 15,404 0.1 11.975 17 V3 0.830 ≤23.140
9 59.076 18.240 87 0 59.076 17 V3 0.830 .23.140
10 5.802 5.713 557 0 5.802 18 V3 0.478 ≤ 26.235
11 20.249 5.045 10,986 0 20.249 18 V3 0.478 .26.235
12 32.533 6.711 2665 0 32.533 19 V3 0.256 ≤15.325
13 64.045 14.525 61 0 64.045 19 V3 0.256 .15.325
14 21.499 25.674 52 0 21.499 22 V3 0.857 ≤ 233.355
15 84.666 8.680 1109 0 84.666 22 V3 0.857 .233.355
16 3.232 5.759 1501 0 3.232 23 V3 0.109 ≤ 223.130
17 16.312 7.958 163 0 16.312 23 V3 0.109 .223.130
18 30.214 5.656 12,290 0.1 30.214 25 V2 1.161 ≤10.185
19 57.669 16.006 367 0 57.669 25 V2 1.161 .10.185
20 43.249 6.175 7178 0 43.249 26 V2 0.502 ≤13.685
21 71.259 12.867 151 0 71.259 26 V2 0.502 .13.685
22 7.449 12.725 215 0 7.449 27 V3 0.181 ≤ 245.005
23 26.490 10.573 249 0 26.490 27 V3 0.181 .245.005
24 23.847 32.229 106 0 23.847 28 V3 0.326 ≤ 278.355
25 55.741 20.183 247 0 55.741 28 V3 0.326 .278.355
26 56.136 6.365 2806 0 56.136 29 V1 0.639 ≤60.535
27 67.112 6.747 2180 0 67.112 29 V1 0.639 .60.535
28 78.725 6.305 1378 0 78.725 30 V1 0.420 ≤84.465

113
29 91.221 5.894 1134 0 91.221 30 V1 0.420 .84.465
114 Y. Ekinci et al.

Step 2. The types of promotion campaigns offered to customers were as follows:

. promotion campaign 1: status quo (no promotion campaign);
. promotion campaign 2: promotion campaign for investment products (different
types of funds, bonds, stocks, repos, and time deposit accounts);
. promotion campaign 3: promotion campaign for credit (personal loans, mortgage
loans, automobile loans, etc.);
. promotion campaign 4: promotion campaign for credit cards.
The transition probabilities between states for the four promotion campaigns were cal-
culated according to the formula given in the previous section. The state to which each
customer belonged was derived based on CART rules. The first rows and columns of
the transition probability matrix are given in Table 4.
As can be seen from Table 4, the transition probabilities for moving from less valuable
states to more valuable ones increase when the various promotion campaigns are applied.
For instance, the probability of moving from state 1 to state 6 is 0.024 in the status quo
situation, while it is 0.027 when an investment products- based promotion campaign (pro-
motion campaign 2) is offered to the customers in state 1. Promotion campaigns for credit
cards (campaign 4) and for investments (campaign 2) are very effective in increasing the
transition probability for moving from state 2 to more valuable states. In state 4, a pro-
motion campaign for credit (campaign 3) is seen to be the most effective promotion
campaign for moving customers to state 6. Similarly, when some marketing promotion
campaigns are applied, the transition probabilities of moving from a more valuable
state to a less valuable one decreases. One example is given by the transition probabilities

Table 4. Transition probabilities matrix.

Promotion campaign States 1 2 3 4 5 6
1 1 0.906 0.006 0.001 0.000 0.012 0.024
2 1 0.912 0.000 0.000 0.000 0.015 0.027
3 1 0.898 0.000 0.000 0.000 0.024 0.023
4 1 0.942 0.000 0.000 0.000 0.006 0.016
1 2 0.525 0.120 0.028 0.028 0.020 0.137
2 2 0.614 0.006 0.000 0.000 0.029 0.127
3 2 0.583 0.000 0.000 0.000 0.010 0.093
4 2 0.580 0.004 0.000 0.000 0.027 0.094
1 3 0.192 0.084 0.206 0.031 0.003 0.157
2 3 0.108 0.011 0.011 0.000 0.000 0.172
3 3 0.108 0.000 0.011 0.000 0.011 0.204
4 3 0.120 0.000 0.012 0.000 0.000 0.169
1 4 0.183 0.108 0.054 0.140 0.000 0.086
2 4 0.250 0.031 0.000 0.000 0.000 0.094
3 4 0.450 0.000 0.000 0.000 0.000 0.150
4 4 0.170 0.000 0.000 0.000 0.000 0.085
1 5 0.335 0.005 0.000 0.000 0.491 0.012
2 5 0.306 0.000 0.000 0.000 0.546 0.011
3 5 0.211 0.000 0.000 0.000 0.479 0.009
4 5 0.293 0.000 0.000 0.000 0.507 0.023
1 6 0.273 0.014 0.009 0.002 0.006 0.512
2 6 0.228 0.004 0.000 0.000 0.007 0.569
3 6 0.181 0.000 0.000 0.000 0.004 0.580
4 6 0.247 0.000 0.000 0.000 0.005 0.506
 The Service Industries Journal 115

for state 3. The transition probabilities from state 3 to state 1 and to state 2 are 0.192 and
0.084, respectively, in the status quo case. However, these probabilities decrease with the
application of any type of promotion campaign.
Step 3.
(1) In order to examine the robustness of the results, the model was solved using 10
different discount factors (ranging from 0.90 to 0.99).
(2) The cost of promotion campaign 1 (status quo) was taken to be 0, while the costs of
the other three promotion campaigns were taken as $3, $2, and $1, respectively.
(3) Using Markov decision processes, the optimal marketing strategies were calcu-
lated with discount rates from 0.90 to 0.99 and an infinite horizon. The total
present values for these 10 discount rates are shown in Figure 2.
As can be seen in Figure 2, there is a breakpoint at 0.95, where the present value starts to
increase rapidly. Therefore, detailed empirical results are shown in Table 5 for discount rates
of 0.90, 0.95, and 0.99. This table includes the maximum values for each state with four
possible promotion campaigns, together with the optimal promotion campaign decision.
The expected values in Table 5 decrease when the discount factor decreases, but gen-
erally the optimal promotion campaign decisions do not change. Therefore the solution is
robust to different a values, but the present values obtained are changed. However, for
state 25 (the mean value of the state is $67.112, one of the most profitable states), when
the discount factor decreases to 0.90, the optimal promotion campaign decision changes
from promotion campaign 2 to promotion campaign 4, which is, in fact, a cheaper one.
Additionally, for state 29 (the most profitable state with mean value of $91.221), the
optimal decision is promotion campaign 2 for a discount factor of 0.99, whereas it is pro-
motion campaign 4 for smaller discount factors. Promotion campaign 2 includes offering
higher interest rates for investment products, so that customers will earn more by investing
in those products.
The values of the states increase from state 1 to state 29. The behaviour of customers in
each state can be evaluated based on this information and on the decision about the optimal
marketing promotion campaign. State 1 consists of those customers with the lowest cus-
tomer value, and it seems that whatever promotion campaign is directed towards them,
they do not move to more valuable states. Hence, the optimal marketing promotion

Figure 2. Calculated present values versus different discount rates.

116 Y. Ekinci et al.

Table 5. Optimal promotion campaigns and present values for states under different discount rates.
Discount rates
a ¼ 0.99 a ¼ 0.95 a ¼ 0.90
Present Present Present
Optimal value of a Optimal value of a Optimal value of a
promotion customer in promotion customer in promotion customer in
State campaign state i ($) campaign state i ($) campaign state i ($)
1 1 2357.024 1 362.270 1 144.294
2 4 2462.178 4 438.455 4 201.131
3 3 2601.270 3 537.287 3 273.651
4 4 2671.699 4 592.588 4 318.112
5 3 2467.899 3 448.634 3 211.621
6 3 2494.538 3 460.540 3 217.218
7 2 2752.789 2 654.518 2 366.703
8 3 2578.123 3 522.350 3 264.707
9 3 2555.345 3 520.001 3 269.967
10 2 2699.852 2 585.008 2 298.798
11 4 2783.003 4 683.085 4 393.710
12 3 2703.026 3 619.847 3 342.832
13 3 2684.118 3 602.964 3 327.988
14 3 2644.896 3 594.571 3 332.647
15 3 2766.487 3 670.218 3 384.270
16 4 2742.538 4 669.381 4 392.565
17 3 2712.351 3 654.557 3 385.823
18 4 2487.679 4 471.436 4 238.909
19 2 2879.259 2 760.903 2 459.323
20 4 2854.691 4 742.577 4 445.241
21 3 2775.661 3 681.565 3 397.145
22 2 2588.484 2 539.886 2 287.092
23 3 2763.606 3 700.666 3 427.134
24 1 2601.532 1 567.458 1 318.558
25 2 2917.168 2 791.867 4 486.539
26 3 2864.446 3 760.865 3 466.658
27 3 3001.774 3 862.103 3 545.446
28 4 2809.301 4 742.232 4 465.521
29 2 2964.373 4 838.383 4 532.518
Total 78185.110 18076.210 10196.120
present
value of
the states

campaign is ‘status quo’. Another state of customers for which the optimal promotion
campaign is found to be campaign 1 is state 24. State 24 includes valuable customers,
and they seem to stay there even when no promotion campaign is offered to them. The
company can hold them in that state by doing nothing. Furthermore, the company may
decrease its profits by directing promotion campaigns to them, since promotion campaigns
are costly. The most costly promotion campaign is campaign 2, with a cost of $3. Custo-
mers in states 7, 10, 19, 22, 25, and 29 respond to this promotion campaign, as moving to
more valuable states increases the overall present value of the company. This finding indi-
cates that the promotion campaign for investment products (promotion campaign 2)
directly increases the value of the most valuable customers, who are in the higher
states, with a few exceptions.
 The Service Industries Journal 117

One important point here is that promotion campaign 2 is not found to be attractive for
any of the customers in the first few states, because of its high cost. Another important
point is that the company does not need to direct any promotion campaign at the customers
in the 24th state in order to keep them as valuable customers of the organization. Undoubt-
edly, the major result of the analysis is that a promotion campaign for credit (promotion
campaign 3) is the optimal promotion campaign for a wide range of customers. Although
we expected to find that loans were generally used by customers who need more financial
support to make ends meet, the analysis in this study indicates that from the least valuable
to the most valuable, customers are influenced by promotion campaigns about credit. The
statistics of the Banks Association of Turkey also support this result, since the loans used
most often in 2009 in Turkey were personal loans (48%) and mortgage loans (46%) (Banks
Association of Turkey, 2009). Personal loans may be used mostly by customers in the less
valuable states, who are trying to meet their basic physiological and social needs and are
not interested in satisfying needs at the higher levels of the Maslow hierarchy. However, a
mortgage loan, which is a high-cost banking instrument, may be preferred by customers in
more valuable states. Promotion campaign 4, which is about credit cards, is also effective
for customers both in less valuable states such as 2, 4, and 11 and in higher states such as
16, 18, 20, and 28. Although this result has not been derived from the study, it might have
occurred because customers in lower states need to have more financial support for their
living expenses and use credit cards because they are short of cash, while customers in
higher states, who are expected to spend a lot and travel more, use credit cards because
of their convenience, validity around the world, availability, and some additional benefits
such as saving air-miles for flight tickets. As a result, credit cards are commonly held and
used by many customers.
Step 4. A comparison with the status quo was performed. Table 6 shows the
expected present values of the customers in each state for different discount factors
and the status quo case (promotion campaign 1). To demonstrate the findings, we
compare some values in Tables 5 and 6. The optimal marketing promotion campaign
for state 2 is found to be campaign 4 and, in this case, the expected value is found to
be $2462.178. However, in the status quo case, the corresponding value is $942.472,
meaning the former value is 2.6 times the latter. Similar findings are obtained for
other states.
The results in Table 6 show that when the problem is solved with an infinite horizon
using stochastic dynamic programming, the total value gained from the various states for
the optimal marketing promotion campaign decision is more than twice the value obtained
for the status quo, but the difference diminishes for smaller discount factors. The total
values in Table 5 for discount factors of 0.99, 0.95, and 0.90 are $78185.110,
$18076.210, and $10196.120, respectively. However, the corresponding values are
$30271.070, $8328.624, and $5391.514 for the status quo. This significant difference
shows us the importance of keeping previous data on customers, mining it, and using
optimization techniques for deciding on future marketing plans.
The results suggest a marketing promotion campaign strategy where campaign 1 is
offered to the customers who are in the lowest state and in one of the higher states
(namely states 1 and 24); campaign 2 is offered to states 7, 10, 19, 22, 25, and 29; cam-
paign 3 is offered to states 3, 5, 6, 8, 9, 12, 13, 14, 15, 17, 21, 23, 26, and 27; and,
finally, campaign 4 is offered to states 2, 4, 11, 16, 18, 20, and 28 if the discount factor
is expected to be 0.99. For a discount factor of 0.95, the optimal decision for state 29 is
changed to promotion campaign 4. Additionally, for a discount factor of 0.90, the
optimal decisions for states 25 and 29 are found to be campaign 4.
118 Y. Ekinci et al.

Table 6. Present values for states under different discount rates for the status quo.
Present value of a Present value of a Present value of a
customer in state i for a: customer in state i for a: customer in state i for a:
State i 0.99 ($) 0.95 ($) 0.90 ($)
1 915.942 169.975 78.901
2 942.472 193.202 99.016
3 970.741 217.924 120.416
4 990.866 235.915 136.339
5 952.775 203.431 109.171
6 962.562 211.790 116.211
7 1008.576 252.881 152.550
8 996.414 242.465 143.862
9 992.313 239.005 141.005
10 1030.088 273.108 171.466
11 1027.111 269.525 167.461
12 1025.178 268.933 168.055
13 1014.734 260.265 161.083
14 1041.021 283.186 180.870
15 1051.766 294.760 193.085
16 1080.652 320.050 214.977
17 1084.853 323.736 218.238
18 974.536 227.858 136.064
19 1106.049 344.269 237.962
20 1097.273 336.613 231.388
21 1074.774 316.715 214.075
22 1008.167 258.033 163.007
23 1129.461 365.360 256.934
24 1064.464 308.082 207.093
25 1128.526 365.809 258.546
26 1108.503 348.185 243.349
27 1150.054 386.474 278.338
28 1167.661 402.173 292.337
29 1173.539 408.902 299.714
Total present 30271.070 8328.624 5391.514
value of the
states

Conclusions
The study described in this paper aimed to determine the states of customers in terms of
their value by using the CART technique, which classifies customers according to their
CLV. Since previous studies have concentrated on optimal marketing strategies for com-
panies offering only one type of product or service; those studies used recency – fre-
quency – monetary values to define the states. However, this may not be efficient for
companies offering more than one type of product or service as in the case of the
finance company analysed in this study. While data on credit-card transactions includes
all of the recency – frequency – monetary values, frequency values do not exist for some
investment products such as forward accounts. Thus, this makes the use of recency –fre-
quency – monetary values impossible, since a customer may have or use many products or
services, such as investment products, and routine services such as electronic fund trans-
fers, cash withdrawal, credit cards, and loans in the case of banking services. In fact, the
reason for using recency – frequency – monetary values in the majority of previous banking
 The Service Industries Journal 119

studies is that these studies were based solely on the segmentation of users of specific bank
service – mostly credit-card customers.
In addition, Tirenni et al. (2007) emphasize that regression-tree-based techniques out-
performed other clustering techniques in analysing the optimal promotion decisions
based on CLV. As a result, the present study used the CART technique which eliminates
the limitations of the previous studies and represents a more effective technique for the
specific service industry in order to determine the states of customers. This allows partition-
ing customers according to a target variable, similar to the study by Haenlein et al. (2007),
who suggest performing a segmentation for retail bank customers using the same technique.
The proposed methodology also includes a solution to the problem of discount factors.
The discount factor in this study is the yearly rate appropriate to investment in marketing.
Businesses need to consider the discount rate when deciding whether to spend some of
their profits on investment or whether to return profits to their shareholders. Therefore
companies can formulate their marketing action plans according to their forecast of the
discount factor, based on the conditions of the market, technology, competition, and
other environmental factors.
The methodology used in this study revealed important findings to guide managers in
deciding an optimal promotion campaign to be directed towards different customer seg-
ments in order to maximize profit.
The methodology shows that an optimal promotion campaign can be determined for
each of the different customer segments based on the CLV. The results underline that
among the three types of promotion campaigns, the promotion campaign for investments
(campaign 2) has a more positive impact on the lifetime value of customers in higher
states than on those in lower states. Thus the banks have to develop effective campaigns
based on investment products including different types of funds, bonds, stocks, repos,
and time deposit accounts for their customer segments with higher CLV in order to increase
their profitability. The other two promotion campaigns, namely campaigns for credit and for
credit cards, are effective in increasing the value of customers in a wide range of states. Thus
these findings indicate that the majority of segments of bank customers are more sensitive
and responsive to the credit-based promotion campaigns. However, compared with the
promotion campaign for credit cards, the analysis of the transition probabilities and of
the impact of discount factors shows that the implementation of credit-based promotion
has a more widespread and ongoing effect on the level of customer value, as well as on
moving customers from their current state to the next higher state in a continuous
manner. Thus, a promotion campaign for credit (promotion campaign 3) as the optimal pro-
motion campaign seems to be most attractive type of campaign for a wide range of custo-
mers to continue their relations with the bank by increasing their value for the institution.
However, promotion campaigns about credit consist of different types of promotions,
including those on personal loans, mortgage loans, automobile loans, etc. Each of these
different types of loans might be used by the customers in order to satisfy different needs.
For instance, a promotion campaign on personal loans might be more effective to increase
the value of customers at lower states compared with those on automobile loans. Thus,
determination of more specific promotion strategies requires the collection and analysis
of data on promotion campaigns on the basis of different types of credit. This allows us
to determine more specific optimal promotion campaigns for each segment of customers.
The promotion campaign for credit cards, on the other hand, has a leveraged impact on
the two ends of the continuum of states. The data on different types of credit-card-based
promotion campaigns have also been collected and analysed here to understand how and
when two extreme states are influenced by the nature of such promotion campaigns.
120 Y. Ekinci et al.

Importantly, all the empirical findings show that while some customers may be indif-
ferent to promotion campaigns, some care about the cost of promotion campaigns and
others really consider the content of the promotion campaigns offered to them. Further-
more, this behaviour is not really in parallel with the value generated by the customers;
in other words, the company cannot be sure that the valuable segments will respond to
the most costly promotion campaign or the less valuable segments will not respond to
them, etc. Therefore, companies should use their data warehouses as effectively as poss-
ible. The past data on customer behaviour collected by companies help them to understand
the various types of customer behaviour.
Additionally, the results show that the total value gained from the states when the
optimal promotion campaign is applied is more than twice the total value in the situation
of the status quo, when the problem is solved with an infinite horizon using stochastic
dynamic programming. As expected, the difference becomes smaller for smaller discount
factors. This result shows us the importance of keeping past data on customers, mining it,
and using optimization techniques to decide on future marketing plans. Undoubtedly, the
most important result derived from this study is that CLV-based segmentation is very
effective for determining optimal promotion strategies.

Limitations and future research directions

Although this study presents information about the impact of the development of different
promotion campaigns on the state of customers in terms of CLV that will be valuable, both to
academics and practitioners, the study has a few limitations. The major limitation is related
to the basic underlying assumption of the proposed model, which dictates that the transition
from one state of CLV to another depends only on the type of promotion campaign directed
towards customers. Undoubtedly, all marketing decisions are taken in an uncontrollable
micro- and macro-environment. For this reason, even if the company has monitored its
environment and it plans reactive and proactive actions on a continuous basis, it is very
difficult to control the impact of all of the changes in the environment on its marketing
strategies. Thus, it is also difficult to argue that the type of promotion campaign is the
unique factor that influences the value of customers in the banking industry. The latter
value is directly affected by the economic, political, and technological environment.
Future studies may consider the impact of at least one of the other factors mentioned
above on the state of customers in terms of CLV. One valuable method might be to
conduct similar studies in two different economic situations, for example, in a period of
economic stagflation and a period of economic stability. By making a comparison
between the two periods, it would be possible to get more reliable results concerning
the impact of promotion campaigns.
Finally, the inclusion of demographic variables in the model would also increase the
value of the study. In fact, the results of the proposed model may show differences accord-
ing to demographic characteristics. Therefore, implementing the model for different
demographic clusters and then comparing the results should provide a more valuable
guide to managers for developing promotion campaign strategies.

Acknowledgements
The authors would like to thank the anonymous financial services company that supplied
the data to perform this research study. This research was supported by Republic of
Turkey, Ministry of Industry and Trade (Project No: 00432.STZ.2009-2) and Istanbul
 The Service Industries Journal 121

Technical University, Institute of Science and Technology (Project No: 34228). The
interpretation and conclusions revealed in this study do not represent the official
perspectives of the institutes stated above. The authors would also like to express their
deep gratitude to the anonymous referees for their invaluable comments.

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