Elsevier

Omega

Volume 29, Issue 1, February 2001, Pages 49-61
Omega

The allocation of promotion budget to maximize customer equity

https://doi.org/10.1016/S0305-0483(00)00023-2Get rights and content

Abstract

Since the early 1980s, the concept of relationship marketing has gained increased acceptance in the field of general marketing, and particularly that of direct and interactive marketing. One of the major benefits of relationship marketing is the ability to make decisions based on their impact on customer equity. In this paper, we offer a general approach to the organization of promotion budget allocation, where the objective function is to maximize customer equity. A cornerstone in our study is the use of decision calculus in which managers’ judgments and/or estimates serve as some of the inputs to formal modeling. A series of applications of our approach to promotion budget allocation are offered under different market conditions. These applications focus on promotional expenditure allocation decisions between acquisition and retention, as well as among different promotional options for each category of expenditure. The paper also treats potential cases of synergy, or interaction, between promotional vehicles when applied to the same market segment.

Introduction

It is the age of relationship marketing [21], [29], an age in which making a sale is just the beginning, rather than the end, of a company–customer relationship. At the core of relationship marketing is the development and maintenance of long-term relationships with customers, rather than simply a series of discrete transactions. One consequence of relationship marketing is, therefore, a major directional change in the criterion variable that should guide managerial decisions. Instead of studying the impact of managerial decisions on one-time-transactional sales or profits, the most appropriate criterion that managers should evaluate when determining a course of action is: how will this action affect the firm’s customer equity [6], [13], [32]?

Customer Equity, also referred to as Customer Lifetime Value (CLV)1, is the “excess of a customer’s revenues over time over the company costs of attracting, selling, and servicing that customer” [21]. It is, therefore, the discounted value, or present value, of the projected net cash flows that a firm expects to receive from the customer over time [7]. The customer lifetime value is used to quantify and measure the conceptually broader marketing concept of customer equity. In this paper, we use customer equity and customer lifetime value interchangeably, a common practice by researchers (see, e.g., Ref. [6], [13]).

Recognizing its importance in decision making, researchers have studied customer equity [3], [6] and its use in a variety of marketing decision problems, such as pricing strategies [3], media selection [16], [20], setting acquisition programs [3], [13], and setting optimal promotion budgets [6]. The purpose of this paper is to offer another managerial application of customer equity, that of optimally allocating an already set promotion budget under different market conditions, focusing on the acquisition/retention allocation. A major contribution of this paper is: (1) its development of a general approach to the optimal allocation of promotion budget through a combination of the two concepts of decision calculus and customer equity; and (2) its discussion and modeling of possible synergy among different promotional vehicles.

In addition to the introduction, this paper has four sections. First, we review previous research on the related topics of promotion budget setting, promotion budget allocation, and decision calculus. Second, we build on work by Blattberg and Deighton [6] to offer a general approach to the optimization of promotion budget allocation between acquisition and retention expenditures. Third, we treat four distinct general market situations, offering, in each case, a setting/framework for optimizing the aforementioned budget allocation. Fourth, we discuss some of the limitations of our study and suggest areas for future research.

Section snippets

Literature review

Managerial decisions pertaining to promotional budgeting and media planning have received a lot of attention by researchers [4], [17], [34]. The attention paid by academicians to promotion budget setting/budget allocation techniques is understandable given: (1) the rising fortunes invested by practitioners in promotion [27]; (2) the highly, and increasingly so, competitive markets in which firms operate [21]; and (3) the complexity of the promotional budgeting topic, which makes it a very rich

A general approach to promotion budget allocation

The discussion of an optimal allocation of a promotion budget assumes that this budget is already set, one way or another, but definitely not by using the objective-and-task technique, where, as discussed earlier, budget setting and budget allocation may not be realistically separated. By budget allocation we mean the monetary allocation between acquisition (of new customers) and retention (of existing customers) using one promotional vehicle, e.g., direct mail. In cases when more than one

Applications of promotion budget allocation

Blattberg and Deighton [6] used their models to determine optimal acquisition spending and, separately, optimal retention spending. They were, therefore, concerned with budget setting. In this paper, we extend their general model of customer equity to optimize the allocation of promotion budget between acquisition spending and retention spending, under several different market situations.

Our first case is the simplest, and addresses budget allocation between acquisition and retention spending

Limitations and suggestions for future research

One of the major implications of relationship marketing is to make marketing decisions based on their impact on customer equity. In this paper, we offer a general approach to the optimization of budget allocation between acquisition and retention spending, using non-linear programming where the objective is to maximize customer equity. A cornerstone in our study is the use of decision calculus where managers’ judgments or estimates serve as inputs to the formal modeling. The paper also

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