CUSTOMER LIFETIME VALUE RESEARCH

IN MARKETING: A REVIEW AND

FUTURE DIRECTIONS
DIPAK JAIN is Dean of the Kellogg
School of Management,
Northwestern University, Evanston,
Illinois.
SIDDHARTHA S. SINGH is a PhD
student in the Department of
Marketing, Kellogg School of
Management, Northwestern
University, Evanston, Illinois.
Please address correspondence to
Dipak Jain, Dean, Kellogg School of
Management, Northwestern
University, 2001 Sheridan Road,
Evanston, IL 60208-2001.

Dipak Jain
Siddhartha S. Singh
f
1. INTRODUCTION
As we go through the information revolution, new marketing
areas and issues are emerging that warrant in-depth research.
New problems present themselves to investigation and old problems can be analyzed in better ways due to the availability of
better data. Customer lifetime value (CLV) analysis is one such
area in marketing that benefits from this new development.
The notion of lifetime value of a customer has been well accepted
by both researchers and business practitioners. It is normally believed that long-lifetime customers are more profitable to a firm.
Reichheld and Teal (1996) attributed the increase in profits from
loyal customers to the price premium paid by loyal customers, the
added profits from sales through referrals, profit from cost savings
obtained by serving an old customer, and revenue growth from a
loyal customer due to increase in sales to that customer. These can
be considered as summary of the commonly held reasons for increase in profitability from long-lifetime customers.
For companies with a presence on the World Wide Web, Reichheld and Schefter (2000) noted that the general pattern of early
losses followed by rising profits from an acquired and retained
2002 Wiley Periodicals, Inc. and
Direct Marketing Educational Foundation, Inc.
f
JOURNAL OF INTERACTIVE MARKETING
VOLUME 16 / NUMBER 2 / SPRING 2002
Published online in Wiley InterScience (www.interscience.wiley.com).
DOI: 10.1002/dir.10032

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CUSTOMER LIFETIME VALUE RESEARCH IN MARKETING

ferings as an opportunity to save on the energy

bill. It obtains value for its customers by offering
any form of energy that can save money for the
customers. BP expects to increase revenue and
decrease costs by gaining longevity, depth,
breadth, and diversity of customer spending
not by obtaining increased revenue per product
(Vandermerwe, 2000).
From a firms perspective, customer life cycle
can be best understood as a series of transactions between the firm and its customer over
the entire time period the customer remains in
business with the firm. Customer life cycle varies
from business to business and customer to customer and could be short or long depending on
the nature of business of the firm, the profile of
its customers, and the interaction between the
firm and its customer. As an example, older
customers with a long history of transactions
with a bank are more likely to be retained and
hence have a longer life cycle as compared to
newly acquired younger customers (Wheaton,
2000).
The increasing importance of the customercentric approach to marketing is evident in the
numerous customer relationship management
initiatives prevalent today, such as one-to-one
marketing and database marketing. Most of
these customer-centric marketing initiatives aim
to increase the length of the customer life cycle
as well as the value of the transactions between
the firm and the customer during each stage of
the life cycle. More and more firms are focusing
on nurturing customer relations for long lifetime of customers with the firm and subsequently for higher profitability and growth. As a
result of this approach, marketing activities and
performance evaluations are increasingly being
organized around relationships with customers
rather than products. This has resulted in a
totally different paradigm for making and evaluating marketing decisions. The focus on relationship management makes it extremely important to understand CLV because CLV
models are a systematic way to understand and
evaluate a firms relationship with its customers.
The purpose of this article is to review various
research articles that have appeared in the marketing literature dealing with customer lifetime

customer is exacerbated on the Internet. Furthermore, the cost of acquiring a customer is

higher on the Internet, and profitability from a
customer can only come if that customer makes
many repeat purchases over the years to come.
This implies that the value of loyalty is often
greater on the Internet than in the physical
world. It is important to understand that loyalty
has value only in the context of profitable customers. Loyalty of unprofitable customers is not
good for a firm.
Until recently, a firms transactions with its customers were treated as discrete activities. To improve profitability, firms focused on costs, product lines, and the competition. Customers were
generally not on the radar screen; that the customer generates revenues that result in higher
profitability was not evident in the decision-making process within firms. A series of transactions
with a customer over a period of time was not
given its due importance in strategy formulation.
This was a direct consequence of a product-centric approach followed by firms.
With an increased understanding of the importance of customer loyalty, firms are taking a more
customer-centric approach to strategy formulation and, as a result, customer life cycle has taken a
central role in marketing strategy as compared to
product life cycle in the past. The product-centric
approach faces certain challenges to success that
can be overcome by the customer-centric approach. In the product-centric view, products are
treated as assets, and firms focus on selling more
products at the highest possible margins, that is,
increasing profits from each product. Both products and cost advantages can be replicated by the
competition. The customer-centric approach, on
the other hand, treats customers (of the products) as assets and focuses on both acquiring and
retaining customers. These retained customers
can form a basis of sustained competitive advantage. Such an approach becomes even more relevant in the new economy where more and more
firms sell services and customer relationship becomes critical in this context (Thomas, 1997).
As a specific example of customer-centric approach, British Petroleum (BP) does not try to
sell business customers more BP fuel to power
their buildings, but rather characterizes its ofJOURNAL OF INTERACTIVE MARKETING

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ately described as customer base analysis where

researchers have proposed various methods to
analyze information about the existing customer base and predict the probabilistic value
of future customer transactions. In this direction, researchers have focused on segments of
customers as well as individual customers. They
have used empirical methods to examine a
range of issues concerning which customer or
segment of customers a firm should focus on
attracting, and retaining, since not all customers are profitable and the relationship between
long-lifetime value of a customer and firm profitability. Finally, the third area has been devoted
to analyzing CLV and its implications for managerially relevant decisions through analytical models. A
particular focus in this area has been on investigating the effect of loyalty programs on CLV
and firms profitability.
CLV models have a variety of uses in all kinds
of business organizations. Particular use of such
models, however, will depend upon the type of
products and customers a firm has. Firms having few and identifiable customers might benefit from models that measure the lifetime value
of individual customers whereas firms having
large number of customers with small sales to
each customer might benefit from models that
help segment customer base on the basis of
lifetime value.
CLV models can be very useful in helping the
firms make strategic as well as tactical decisions:
that is, strategic decisions in terms of identifying
who its customers are and their characteristics
and which customers to go after in the long run,
and tactical decisions in terms of short-term
resource allocations among marketing variables
and the focus of marketing activities.
CLV models help quantify the relationship of
the firm with its customers and subsequently
allow the firm to make more informed decisions
in a structured framework. CLV models also
help a firm to know who its profitable customers
are, and customer profitability provides a metric
for the allocation of marketing resources to
consumers and market segments. Marketing efforts are best directed at the most profitable
consumers (Mulhern, 1999).
The coming of the Internet age has increased

value, summarize their findings and possible

extensions, and present directions for future
research.
The rest of this article is arranged as follows.
The next section describes the current research
focus in CLV. Section 3 explains the CLV concept and presents some important models in
CLV literature. Section 4 contains a general
discussion on directions for future research and
provides a conclusion.

2. RESEARCH FOCUS
Considerable research in CLV has concentrated mainly in the realm of direct marketing, primarily because direct marketing provided access to information about individual
customers that enabled investigation of relevant issues. The information revolution is
changing all this. As we move into the Internet era, presence of a company on the Web is
no longer a luxury or competitive advantage;
rather it is a must for survival. Better information on individual customers is available today
because of this development. This new source
of information has renewed interest in customer lifetime value among marketing researchers.
Reinartz and Kumar (2000) explained that
the interest in customer lifetime value research
has increased recently, mainly for three reasons.
First, firms are now more and more interested
in customer management processes for which
an understanding of customer lifetime value
concept is a prerequisite. Second, the Marketing Science Institute has elevated the topic to a
capital research priority. Third, empirical evidence is particularly scarce in this CLV domain.
The literature in customer lifetime value
(CLV) research in mainstream marketing has
taken multiple directions. However, the main
focus of most of the studies in CLV research has
been threefold. The first is the development of
models to calculate the CLV for each customer.
These articles focus on customer acquisition
cost, customer retention cost, other marketing
costs, and the revenue stream from the customer to calculate CLV.
The second stream can be more appropriJOURNAL OF INTERACTIVE MARKETING

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costs when thinking about the CLV.1 For example, consider a company that spends a million
dollars to attract customers. If only a few customers actually make a purchase worth a few dollars
each in the first period, then the costs incurred in
the first period are acquisition costs, and ignoring
this in the CLV models would give a positive lifetime value to each customer even though they
may never make a purchase after their first purchase. Clearly the lifetime value of such customers
cannot be positive. In short, CLV is a concept that
is forward looking, and the right definition and
modeling should consider the essence of the concept as against rigid definitions.
Many models have been proposed in CLV
literature dealing with all kinds of issues related
to CLV. The following selection of models provides summaries of some key models addressing
some major research opportunities in CLV research and applications. Based on the threefold
stream of research related to CLV, this section is
divided into three corresponding categories:

the importance of CLV models manifold. Many

companies on the Internet do not have highly
valued physical assets. Such companies can be
valued correctly only when the value of their
intangible assets is taken into account. Since the
value of their customer base is the most important intangible asset that these companies have,
understanding the lifetime value of the customers of the company gives a more accurate picture of the potential in such a company.
The era of mass marketing is being replaced
by an era of targeted marketing. Knowledge of
CLV enables firms to develop customer-specific
marketing programs leading to an increase in
efficiency and effectiveness of such programs.
The Internet is undoubtedly a major instrument of such targeted marketing; the direct
marketing concepts of CLV can be extended to
be useful in interactive scenarios. We present
below a definition of CLV.

3. DEFINITION AND MODELS OF CLV

A). Models for calculation of CLV
B). Models of customer base analysis
C). Normative models of CLV

Customer lifetime value for a firm is the net

profit or loss to the firm from a customer over
the entire life of transactions of that customer
with the firm. Hence the lifetime value of a
customer for a firm is the net of the revenues
obtained from that customer over the lifetime
of transactions with that customer minus the
cost of attracting, selling, and servicing that customer, taking into account the time value of
money (Berger & Nasr, 1998).
In the literature, CLV also appears under
other names such as customer equity and customer profitability. To measure customer equity, Blattberg and Deighton (1996) proposed
the following method:

We first describe the models proposed for

calculating CLV.

A. Models for Calculation of CLV

This category includes models that are specifically formulated to calculate the CLV and/or
extend this calculation to obtain optimal methods of resource allocation to optimize CLV.
These are applied models and more relevant to
practitioners who wish to use CLV as a basis for
making strategic or tactical decisions. In this
category, we have included four types of models. Variations of these four basic models can be

First measure each customers expected contribution towards offsetting the companys fixed
costs over the expected life of that customer.
Then discount the expected contributions to a
net present value at the companys target rate
of return for marketing investments. Finally,
add together the discounted, expected contributions of all current customers (pp. 137138).

1
CLV has also been considered without taking into account the
acquisition cost of customers even in the case of new customers
(Berger & Nasr, 1998). Their reason for not including acquisition
cost is that they have an alternative interpretation of CLV as the
maximum profitable acquisition cost. Therefore, they argue that
even for new customer analysis, CLV should not include acquisition cost, in order to get their interpretation.

We believe that, in the context of new customers, it is important to consider the acquisition
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Dwyer outlined two fundamental CLV approaches corresponding to the two types of
customer categorization. He stated that a lostfor-good situation is best modeled as customer retention problem and he used a slight
variation of the basic model of CLV calculation described before in Basic Structural Model
of CLV. For always-a-share customers, Dwyer
described a customer migration model. This
model uses purchase recency to predict purchase behavior. In each season, customers
have an opportunity to purchase and, based
on their past purchase behavior, the purchase
propensities of each recency cell is estimated.
Depending on the number of purchase periods and recency cells the analyst seeks to
model, a general matrix of purchase propensities is produced. Recency cells refer to cells
in the matrix that contain information regarding the time period of past purchase.
This matrix has recency cells on one axis and
time periods on the other axis. At the expiration of each period, purchasers move up to
recency cell number 1 while non-purchasers
age into the next older recency cell.
The model proposed by Dwyer has an advantage over the basic structural model in that it
considers the probabilistic nature of customer
purchases. Based on past purchase behavior,
the purchase probabilities are updated. Hence
a customer might still be considered retained by
a firm even if she does not purchase in any
particular period(s). This feature in Dwyers
model makes it more realistic. The model is still
simple enough to be used in practice.
Despite its strengths, Dwyers model does
have some important weaknesses. The time period is fixed and the sale and cash flow are
assumed to occur in the same period and at the
same time in each period. Although the model
assumptions make good sense for certain types
of businesses such as magazine subscriptions,
other types of businesses where the revenue
stream is more uncertain might not be able to
justify the use of this model. In addition, the
propensities of purchase in each period are
assumed to be the same and depend only on the
period of last purchase.

numerous depending on the specific task, availability of data, and the user.
(a). Basic structural model of CLV.

1RdC
n

CLV

i
i0.5

i1

where i the period of cash flow from customer transaction; Ri revenue from the customer in period i; Ci total cost of generating
the revenue Ri in period i; n the total number
of periods of projected life of the customer
under consideration.
In this model, it is assumed that all cash flows
take place at the end of a time period.
This model identifies a class of different CLV
models based on the net present value (NPV) of
the future cash flows from customers. This basic
idea of NPV captures the essence of such models. Some important features of these models
are that they assume a particular time of cash
flow that is the same in each time period, they
apply only to customers who are doing business
with the firm, they ignore past as well as prospective customers, they ignore acquisition
costs, they do not consider a number of important factors such as the stochastic nature of the
purchase process and timing of cash flows, and
they are very simple and therefore easy to use.
Berger and Nasr (1998) give an excellent
overview of some CLV models that are build on
this basic model.
(b). Customer migration model. Dwyer (1997)
described a customer migration model for CLV
analysis. Referring to the categorization of industrial buyers as described by Barbara Jackson
(1985), he proposed that customers can be
broadly divided into two groups: always-a-share
and lost-for-good. In the former, customers may
rely on several vendors and can adjust their
share of business done with each whereas in the
latter category, customers have made long-term
commitments to a vendor because switching
vendors is costly and assets dedicated to the
transaction cannot be redeployed easily.
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This model uses CLV as a basis for making

optimal decisions of marketing resource allocation, unlike other models discussed previously
where the objective had been to calculate CLV
only. Further, this model takes into account the
expenses on customer acquisition for calculating CLV. Although this model adds new dimensions to the existing CLV models, it continues to
suffer from some of the same old weaknesses
that other models have had. In particular, the
time period for cash flow remains constant and
cash flows are assumed to occur at the same
time in each period. In addition, the model
does not consider customer acquisition and retention jointly to maximize customer equity.
Berger and Nasr-Bechwati (2001) recently proposed a general approach to address the problem
of optimal allocation of the promotion budget to
maximize customer equity. Their method uses
decision calculus to maximize customer equity by
considering optimal promotional expenditure allocation decisions between customer acquisition,
customer retention, and other promotional options. In addition, they offer a series of applications of their approach under different market
conditions. Their approach recognizes the limitation of marketing budget and considers the tradeoff between spending on customer acquisition
and customer retention.

(c). Optimal resource allocation models. Blattberg and Deighton (1996) propose a managerially relevant model for finding the optimal balance between spending on customer acquisition
and customer retention in order to maximize
CLV. They further propose that customer equity
gains and losses should be tracked against marketing programs. This might highlight problems that
income statement conceals and would put customer at the forefront of strategic thinking. Their
model consists of two parts:

Optimal level of acquisition spending

a ceiling rate1 expk1 $A

The net contribution margin from acquiring a

prospect in the first year a$m $A
Where $A the acquisition expenditure per
prospect; a the acquisition rate obtained as a
result of acquisition expenditure; ceiling rate
the limit to attraction of new customers; k1
parameter controlling the shape of the exponential curve.

Optimal level of retention spending. The following equation describes how customer
equity depends on retention spending:
r ceiling rate1 expk2 $R

(d). Customer relationship models. Pfeifer

and Carraway (2000) proposed that a general
class of mathematical models called Markov
Chain Models (MCM) are appropriate for modeling customer relationships. The authors believed
that MCM models are very flexible and can address the situations depicted in models proposed
by Berger and Nasr (1998), Blattberg and Deighton (1996), and Dwyer (1997). MCM can be used
to model both customer retention and customer
migration situations. In most CLV models, when a
customer stops being active, then the customer is
treated as dead and returning customers are
treated as new customers. In such models, there is
no provision for a customer to be inactive for
sometime while still being retained. Customer migration refers to such a situation where a customer might remain inactive for some periods
and still be treated as a retained customer on

Year y contribution from retention r[$m

$R/r]
Where $R the retention expenditure per
prospect; r the retention rate obtained as a
result of the retention expenditure; k2 the
parameter controlling the shape of the exponential curve; $m the margin we earned in
the year we acquired the customer; it is assumed
to remain the same in each year thereafter.
The annual values for each year of the customers projected life are summed up, add the
value of a first year customer, discount to the
present value at a rate of return appropriate for
marketing investments, d%, and so obtain the
amount of customer equity attributable to that
customer. The optimal level of retention and
acquisition spending is the level at which customer equity is maximized.
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firm expect next year by those on the list, both

individually and collectively.
The proposed model is as follows:
For

his/her return. The probabilistic nature of MCM

allows accounting for the inherent stochasticity in
customer relationships. Pfeifer and Carraway
demonstrate the use of MCM in various situations
and show how to construct the key elements of
MCM, that is, the transition probability matrix
and the reward vector.
Among the models described in this section,
although Markov Chain based models are the
most flexible, the models proposed have critical
assumptions underlying them. Specifically, in
these models, time period for purchase by all
the customers is again assumed to be same, and
fixed. The calculation of transitions probabilities is critical to the success of such models and
these probabilities are not easy to compute.
Another application of MCM is available in
Rust, Zeithaml, and Lemon (2000).

P Alive/r, s, , , x, t, t

s
rxs

T rx T s
Fa1 , b1 ; c1 ; z1 t
t
t
T s
Fa1 , b1 ; c1 ; z1 T

a1 r x s

B. Models of Customer Base Analysis

Such models take into account the past purchase behavior of the entire customer base in
order to come up with probabilities of purchase
in the next time period. These models take into
consideration the stochastic behavior of customers in making purchases and therefore
these models look at each customer individually
in order to compute the probability of purchase
in the next time period. Models in this category
can provide input for the calculation of CLV.
One model that clearly represents this category is the Pareto/NBD model described below.

b1 s 1
c1 r x s 1
z 1 y

where r, s, , are model parameters; t is the

time since trial at which the most recent transaction occurred; T is the time since trial; F(a1,
b1; c1; z) is the Gauss hypergeometric function; x
is the number of purchases the customer makes
in time period (0, T] with the last purchase
coming at time t T. It is assumed that the
customer is alive (active) at time 0.
The probabilities corresponding to and
are given in Schmittlein et al. (1987, p. 6).
The Pareto/NBD model is applicable in contexts where the time when the customer becomes inactive is unknown to the analyst and
the customer can make any number of purchases, at any time, and can become inactive
any time. This model can be very useful to firms
having few long-term customers. Schmittlein
and Peterson (1994) proposed a suitable
method of estimation for the Pareto/NBD
model parameters.
Pareto/NBD type models proposed in CLV
literature have limitations concerning the input

(a). Pareto/NBD model.

Schmittlein, Morrison, and Colombo (1987)
proposed a model, called the Pareto/NBD
model, that calculates the probability that a customer is still active. The model requires the
number and timing of customers previous
transactions as input. Using this model, firms
can identify and count the customers who are
still active. The authors demonstrated that this
model can be used to answer questions about
the number of retail customers that a firm has,
the growth of this customer base over the past
year, which individuals in the customer group
most likely represent active and inactive customers, and what level of transactions should the
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3. The notion that customers with long tenure are associated with lower promotional
costs is rejected.
4. Long lifetime customers do not pay
higher prices.

data requirement for each model. Such models

might give misleading results if a data string of
transactions for more than two years for a customer is included as an input to the model. The
implicit stationarity of Pareto/NBD model is
strained by very long (purchase) histories
(Schmittlein et al., 1987).
In the calculation of CLV, the most critical
part is the determination of the number of
customers who are still active and the number
of customers who will be active in each future
time period. This model provides a sophisticated way to get these probabilities of a customer being active in each time period. The
probabilities thus obtained can then be used to
calculate CLV.

Note that these are contrary to previous findings (Reichheld & Teal, 1996) as discussed in
the Introduction section.
Reinartz and Kumar (2000) found that even
three years of data might not be adequate to
yield complete insight into the phenomenon.
They further say that different consumers have
different frequency of purchase and if short
time periods are considered for analysis, then a
profitable customer might come out as unprofitable. Careful consideration is needed for
counting the first purchase in the model. These
factors should be considered carefully for the
modeling to be meaningful.
The very sophisticated nature of the above
presented models makes them difficult to use in
practice. In addition, the consideration of each
customer individually in order to establish individual probabilities of purchase makes these
models less useful as the number of customers
in the customer base increases and the dollar
amount purchased by each customer decreases.

(b). Extended application of Pareto/NBD

model. Reinartz and Kumar (2000) present a
structured framework for identifying the customer lifetime profitability pattern in a noncontractual context. A noncontractual setting implies a setting where the type of product,
quantity of product purchased, and timing of
purchase depend completely on the customer
and are uncertain from the point of view of the
seller. The authors extend the Pareto/NBD
model of Schmittlein et al. (1987) by transforming the continuous probability estimate of a
customer being active into a dichotomous
alive/dead measure. Using the information
about a customers time of birth and a specified probability level (threshold), they approximate when a customer is deemed to have left
the relationship. The time of birth until the
date associated with the cut-off threshold then
constitutes the lifetime of the customer. The
procedure allows calculation of a finite lifetime
for each customer, which is used for the profitability analysis. The authors use their framework to test four commonly stated propositions
regarding the profitability of long-lifetime customers and conclude the following:

C. Normative Models of CLV

These models have been proposed and used
mainly to understand the issues concerning
CLV. Managers depend on many commonly
held beliefs in making decisions regarding CLV.
As an example, it is believed that long lifetime
customers are more profitable. Numerous researchers and practitioners have provided many
reasons in support of this belief. However, as
noted previously, recent research to explore
this issue has found contradictory evidence.
Normative models provide us an opportunity to
explore this issue without the noise encountered by empirical studies. Such models provide
valuable insight for policy-making. Following
are two models that are typical of this category.

1. The relationship between customer-lifetime and profitability is positive, but weak.

2. No support for the argument that profits
from long life customers increase over
time.
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(a). Customer equity model. Blattberg and

Thomas (2000) proposed a fundamental equation of customer equity, as follows:

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N S

mix on the long-term value of the firms customer base. They propose using customer equity principles to analyze and manage the marketing function. Their model offers a means to
determine the validity of some of the qualitative
findings (often incorrect) on customer relationship marketing.

CEt

i,t

i,t

i,t

ci,t Ni,t Bi, ,t

i0

i,t

i,t i,yk

Si,tk ci,tk Bi,r,tk

k1

Bi, AO,tk

1
1d

(b). A dynamic pricing model based on CLV.

Blattberg and Thomas (1997) proposed a
model for dynamic pricing strategy to maximize
CLV, as follows:

CEt k
t

CE

k0

CEFI

s1

Psa Csa ENsa Psa , Ba

Psr Csr
Ns Ba
1d
t2

1
Br ENst Psr , Br
1d

where CEFI() customer equity financial index for customers acquired at time ; Psa introductory price offered to segment s; Psr retention price offered to segment s; Csa
average product cost in the acquisition period per customer from segment s; Csr average product costs in the retention period per
customer from segment s; E(Nsa( )) expected number of customers acquire in the first
period from segment s; E(Nst( )) expected
number of customers at time t from segment s;
Ba acquisition marketing expenditures per
customer; Br retention marketing expenditures per retained customer; d discount factor; S total number of customer segments; s
customer segment s; Ns number of prospects in segment s at time .
Customer acquisition is defined as the customers first purchase whereas a retained customer is active in every time interval, with no
lapse periods. In this model, a survival function
is used to model the probability that a consumer is active at time t. Using this survival
function, a specification of the firms demand is
obtained. This demand is used to derive the

The profit from first-time customers (which is

the number of prospects contacted times the
acquisition probability times the margin) minus the cost of acquiring the customers (which
is the number of prospects times the acquisition cost per prospect) plus profits from future
sales to these newly acquired customers (which
is the retention rate in each future period
times the profit obtained from the customer in
that period summed across all future periods)
divided by the discount rate which transforms
the future profits into current dollars (or any
currency), summed across all customer segments.

The authors propose the use of this model to

analyze the effects of elements of the marketing
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where CE(t) the customer equity value for

customers acquired at time t; Ni,t the number
of potential customers at time t for segment i;
i,t the acquisition probability at time t for
segment i; i,t the retention probability at
time t for a customer for segment i; Bi,a,t the
marketing cost per prospect for acquiring customers at time t for segment i; Bi,r,t the marketing costs in time period t for retained customers for segment i; Bi,AO,t the marketing
costs in time period t for add-on selling for
segment i; d the discount rate; Si,t Sales of
the product/services offered by the firm at time
t for segment i; ci,t Cost of goods at time t for
segment i; I the number of segments; i the
segment designation; t0 the initial time period; k the time since acquisition.
According to this model, customer equity
equals:

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understanding about the value of a customer to

a firms success, activities of a firm are now
geared more toward developing long-term relationship with a customer. CLV models provide a
systematic way to understand which customer to
focus upon, estimate the lifetime value of a
customer, and analyze the effects of different
actions of the firm on this lifetime value and
hence indirectly on the value of the firm.
Customer relationship management allows
firms to distinguish between customers that are
profitable, nearly profitability, unprofitable,
and have the potential to be profitable. This
kind of knowledge can help firms make focused
and more effective decisions. It is common
knowledge that loyal customers stay longer with
a firm and are more profitable because they are
cheaper to serve, they pay higher prices, and
they refer new customers, and so on. However,
most of these propositions have not been tested
rigorously through research. A few research papers that do address these propositions find
contradictory evidence, or conditional support.
It will be interesting to see how future research
shapes our perception of customer loyalty and
subsequently of CLV.
A number of important marketing issues
need reexamination in light of the influence of
new technologies on marketing. As an example,
the Internet makes it easier for consumers to
visit different vendors at the click of a button
opening up numerous opportunities of purchase, thus making it difficult for vendors to
lock in customers. However, the absence of personal interaction makes it difficult for customers to trust a new vendor easily (Reichheld &
Schefter, 2000). The effect of the interplay of
these, and other such forces should have a definite impact on customer lifetime value. CLV
research is only taking-off today; its huge potential will be exploited in years to come. We
provide below some specific directions for future research.

optimal pricing decision. The Customer Equity

Financial Index is optimized over acquisition
and retention prices to obtained optimal prices
for customer acquisition and customer retention.
From their analysis, the authors find that if a
high price sensitive segment with low long-term
customer value is added to the market, the firm
should increase its acquisition price. Acquisition pricing is determined by the long-term
value of the customer and if the long-term value
is high, acquisition price is low, retention parameters affect acquisition pricing, and retention pricing depends upon a number of parameters, including the cost of retention, the
retention price sensitivity of the customer and
the amount spent on retention marketing.
The authors propose that this model could
provide a way to investigate the return on marketing investment in different segments. Models in this category could provide important
guidelines to the practitioner for the strength
and direction of marketing investment by studying the impact of different decisions on CLV.
They believe that such a model will shift the
goals of marketing from sales and short-term
output measures to new measures related to
customer acquisition, retention, and add-on
selling.
The above categorization of CLV models is in
no way unique. Our intention has been to
present CLV models in a systematic framework
that gives a clearer picture of this literature and
puts different research efforts in perspective.

4. GENERAL DISCUSSION AND

DIRECTIONS FOR FUTURE RESEARCH
In recent years, the focus of companies has
shifted from treating customers as just an entity
involved in the business process to treating
them as a crucial component of their success. In
particular, the importance of a customer is no
longer judged by his/her single transaction
with the firm, but rather by the series of transactions/potential transactions with the firm. Because of this increase in importance of customer relationship due to the enhanced
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CLV Models
1. All the models proposed for calculating CLV
have some limitations. These limitations take
the form of either restrictions on the amount of
cash flow from a customer, or the timing of cash

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such as those that drive the consumers to purchase, the effect of marketing activities on
them, and factors that influence the consumers
to purchase products from the same company
on multiple occasions such as switching costs
and influence of marketing, can be incorporated into CLV models to develop a more complete model.
6. Very few studies consider both customer
acquisition and retention in the same model.
Notable exceptions are Berger and Nasr-Bechwati (2001) and Blattberg and Deighton (1996).
Since acquisition costs are important in determining the net profitability from a customer,
models that include both acquisition and retention of a customer are more meaningful. More
research is needed into such models (Thomas,
2001).
7. Most models in CLV deal with deterministic cash flow stream from the customer. Although in contractual settings, such models do
have limited use, in most settings, such models
are clearly inadequate. The Pareto/NBD model
proposed by Schmittlein et al. is an exception.
Models that incorporate the inherent stochasticity in the purchase process may provide additional insights.
8. More research is needed in accurately predicting CLV based on history of usage and prior
estimates of CLV. Perhaps a Bayesian approach
(i.e., Gibbs sampling) to estimating CLV may be
appropriate in this context. Such an updating
approach may provide more accurate estimates
of CLV than the traditional regression analysis
of historical data.

flow, or the type of business the model is applicable to, or the type of data that is needed, and
so on. Research has been limited to some variations of the basic model, the Pareto/NBD
model, and Markov chain models. Their restrictive assumptions, complications, and limited applicability limit their use significantly. Practitioners still use very basic models to estimate CLV.
A key component of CLV models is the frequency and value of future transactions of a
customer or customer segment, with a firm.
Very little work has addressed this issue. More
research is needed to develop models that are
robust, simple, and flexible.
2. Empirical validation of many CLV models
is lacking. Research is needed into estimation
methods that provide stable, consistent, and unbiased estimates. Schmittlein and colleagues
(Schmittlein et al., 1987; Schmittlein & Peterson, 1994) do an excellent job of testing different estimation methods and finally propose a
two-step estimation method for estimation of
their model.
3. Reichheld and Teal (1996) mention that
long-lifetime customers are profitable because
they pay premium prices, refer other customers,
are cheaper to serve, and pay more. They specifically mention that general merchandise retailing and direct mail industries should support these propositions. Reinartz and Kumar
(2000) investigate the relation of long-lifetime
of customers to profitability by testing the four
commonly held notions as summarized by
Reichheld and Teal (1996) in the general merchandise catalogue industry and reject all four
propositions. Clearly more research is needed
to investigate these differences in findings.
4. Most CLV models do not include demographics and product usage variables. Research
is needed to extend such models to incorporate
such variables. Until now, researchers have
looked into specific product categories. It is
clear that not all models have applicability in all
product categories. More research is needed to
develop new models for different product categories, or modify existing models for different
product categories.
5. The existing CLV models do not look at
the consumer side of the transaction. Factors
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Decision Support Models

Based on CLV
1. More research is needed into development
of models for marketing decision making that
incorporate customer lifetime value. One example is a customer segmentation model that considers CLV as a key basis for segmentation.
2. CLV research makes it possible to investigate the return on marketing investment. Until
now, measuring the return on marketing investment has been extremely difficult. CLV analysis
takes us a step closer to measuring a direct
impact of marketing and as a result it can be

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and satisfaction on customer loyalty has been

well researched. The rapid development of new
technologies has had a significant impact on the
marketing process and old concepts need to be
reexamined in light of these developments. In
particular, the effect of interactive marketing
on trust and customer satisfaction needs research.
In this study, we have presented a number of
models and discussed several studies dealing
with CLV. We believe that significant research is
still needed to make any definite conclusion
about the effects of increased CLV. Some limitations in the current models of CLV have to be
addressed to make them useful in practice.
Given the relevance of this area to practitioners
and the increasing focus of researchers on CLV,
we are optimistic about the growth of marketing
research in this area. Through this study, we
have taken a small step to put the research on
CLV in a framework that might make it easier
for interested entities to view the current state
of research on CLV in proper context. Through
this effort we hope to provide a wider view of
research on CLV, and useful and interesting
research directions.

used to develop models to measure the impact

of marketing on a firms business.
3. Research is needed into what factors determine customer profitability, what factors determine the distribution of profitability across
consumers, and how customer profitability measures should be incorporated into marketing
planning (Mulhern, 1999).
4. To optimize long-term profit, a firm needs
to have a proper balance between spending on
acquiring new customers and spending on retaining old customers. A direct consequence of
this is the right mix of acquisition and retention
prices. This concept of optimal acquisition and
retention pricing needs further exploration.

Customer Loyalty Programs

and Firm Profitability
1. Effectiveness of customer loyalty programs
is another area of research. Dowling and Uncles
(1997) write that the most common objective
for loyalty programs is to retain existing customers and in doing so: (1) maintain sales levels,
margins, and profits, (2) increase the loyalty
and potential value of existing customers, and
(3) induce cross-product buying by existing customers. Their study raises doubts that long-lifetime customers are always profitable. In-depth
investigation is required to study the benefits of
customer loyalty programs as compared to
other alternatives such as a price cut, a move to
everyday low pricing, increased advertising, or
an increase in distribution coverage (Dowling &
Uncles, 1997).
2. Different types of loyalty programs are
prevalent in the market and all the programs do
not have the same impact on CLV and firm
profitability. Specifically, some programs are
based on reduction of purchase price paid by
customers who participate in the programs, an
example being point-of-purchase coupons.
Other types of programs are those that do not
reduce prices but impact the mind of the consumers such as focused educational programs.
There can be many such divisions among loyalty
programs on various dimensions. The impact of
different types of program on CLV needs more
research.
3. The effect of various factors such as trust
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