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The Customer Equity and Lifetime Management (CELM) solution is based on a decision-support system that offers marketing managers a scientific framework for the optimal planning and budgeting of targeted marketing campaigns to maximize return on marketing investments. The CELM technology combines advanced models of Markov decision processes (MDPs), Monte Carlo simulation, and portfolio optimization. MDPs are used to model customer dynamics and to find optimal marketing policies that maximize the value generated by a customer over a given time horizon. Lifetime value optimization is achieved through dynamic programming algorithms that identify which marketing actions, such as cross-selling, up-selling, and loyalty marketing campaigns, transition customers to better value and loyalty states. The CELM technology can also be used to simulate the financial impact of a given marketing policy using Monte Carlo simulation. This allows marketing managers to simulate several targeting scenarios to assess budget requirements and the expected impact of a given marketing policy. The benefits of the solution are illustrated with the Finnair case study, where CELM has been used to optimize marketing planning and budgeting for Finnair's frequent-flyer program (FFP).
Key words: marketing optimization; loyalty programs; Markov decision processes; portfolio optimization; marketing budget allocation; customer equity; customer lifetime value
History: This paper was received August 29, 2005, and was with the authors 7 months for 2 revisions; processed by Gary Lilien.
1. Introduction
The airline industry has made great improvements in customer relationship management. It is awash in customer data, yet most frequent-flyer programs (FFPs) take a "one size fits all" approach to marketing and service differentiation within a given elite level. Despite technological advances and data abundance, most airlines continue to guess customer value, or use inaccurate models for customer valuation. Moreover, most airlines consider the upper tier of their FFP to be their most valuable customer segment. Yet most of today's FFPs are one-dimensional, concentrating primarily on miles flown or points accrued. Unfortunately, however, elite-level travelers are not necessarily the most profitable, nor may they even be the most loyal. Although they might accumulate the most miles, they may not pay the highest fares and may be very costly to serve (for an extensive general discussion of principles and pitfalls of Loyalty Programs, see Shugan 2005).
The emergence of low-cost carriers...