Balancing Acquisition and Retention Spending for Firms with Limited Capacity

Anton Ovchinnikov (), Béatrice Boulu-Reshef and Phillip E. Pfeifer ()
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Anton Ovchinnikov: Darden Graduate School of Business, University of Virginia, Charlottesville, Virginia 22903
Phillip E. Pfeifer: Darden Graduate School of Business, University of Virginia, Charlottesville, Virginia 22903

Management Science, 2014, vol. 60, issue 8, 2002-2019

Abstract: This paper discusses the interaction between revenue management and customer relationship management for a firm that operates in a customer retention situation but faces limited capacity. We present a dynamic programming model for how the firm balances investments in customer acquisition and retention, as well as retention across multiple customer types. We characterize the optimal policy and discuss how the policy changes depending on capacity limitations. We then contrast the modeling results with those of a behavioral experiment in which subjects acted as managers making acquisition and retention decisions. In the modeling part of the paper, we introduce a concept of the value of an incremental customer (VIC), and show that when capacity is unlimited, VIC equals customer lifetime value (CLV), but when capacity is limited, VIC is much smaller and changes dynamically depending on the number of customers and their mix. As a result, the optimal spending is constant and depends on CLV for the firms with unlimited capacity, but changes dynamically and is generally unrelated to CLV when capacity is limited. In the experimental part, we introduce a concept of conditional optimality for the analysis of state-dependent decisions. Applying this concept to our data, we document a number of decision biases, specifically the subjects' tendency to overspend on retaining high-value customers and underspend on lower-value customers retention and acquisition. We show that providing CLV information exacerbates these biases and leads to a loss of net revenue when capacity is limited, but providing information about the marginal costs of acquisition and retention eliminated these biases and increases net revenue.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1842 . This paper was accepted by Yossi Aviv, operations management.

Keywords: behavioral operations; revenue management; limited capacity; customer relationship management; customer lifetime value (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (9)

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Working Paper: Balancing Acquisition and Retention Spending for Firms with Limited Capacity (2014)
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