Tuesday, April 17, 2012

Estimating Customer Profitability

How can one predict the future?

Given that customers are fickle and firms are inconsistent the idea of predicting future behavior, much less profitability, is fraught with perils.   In fact, it is often the answer to 'what have you done recently?' that is the best predictor of future profits.   While current or average profit is a naive assumption it often out performs much more complex approaches.   Recent research took a stab at addressing the question again focusing on a series of questions.
  1. What marketing activity is the customer likely to encounter in the future?
  2. What is the likelihood of purchasing given the contact plan?
  3. What is the probable profit given that a future purchase is likely?
Each question results in a series of estimates for every customer across the planning horizon of 12 quarters.  To assess whether it works, the summary looks at customers at two different points in time and plots the migration of people across profitability segments. 

Since the answers are all estimates and subject to error the authors added a nice twist; they simulated a 1,000 different futures for each customer based on the uncertainty in answering the above questions and then pooled the results.   This approach of creating a myriad of potential outcomes worked better than the benchmark models.

Like so many marketing problems, the future is all about best guesses based on alternative reality rather than the certainty of a point estimate.   

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