"Counting Your Customers" One by One: An Individual Level RF Analysis Based on Consumer Behavior Theory

In customer relationship management (CRM), ad hoc rules are often employed to judge whether customers are active in a "non-contractual" setting. For example, a customer is considered to have dropped out if he or she has not made purchase for over three months. However, for customers with a long interpurchase time, this three-month time frame would not apply. Hence, when assessing customer attrition, it is important to account for customer heterogeneity. Although this issue was recognized by Schmittlein et al. (1987), who proposed the Pareto/NBD "counting your customers" framework almost 20 years ago, today's marketing demands a more individual level analysis. This research presents a proposed model that captures customer heterogeneity through estimation of individual-specific parameters, while maintaining theoretically sound assumptions of individual behavior in a Pareto/NBD model (a Poisson purchase process and a memoryless dropout process). The model not only relaxes the assumption of independence of the two behavioral processes, it also provides useful outputs for CRM, such as a customer-specific lifetime and retention rate, which could not have been obtained otherwise. Its predictive performance is compared against the benchmark Pareto/NBD model. The model extension, as applied to scanner panel data, demonstrates that recency-frequency (RF) data, in conjunction with customer behavior and demographics, can provide important insights into direct marketing issues, such as whether long-life customers spend more and are more profitable.