Dynamic Targeted Promotions: A Customer Retention and Acquisition Perspective
Washington University WP OLIN-96-32
Posted: 16 Jul 1997
Date Written: June 1996
This research analyzes the strategic use of targeted promotions for customer retention and acquisition in a dynamic and competitive environment. We develop suitable differential games for both finite- and infinite-time problems and provide analytical solutions in each case for defensive and offensive Nash equilibrium closed-loop strategies. Our analysis shows that a firm's optimal targeting strategies, both offensive and defensive, in a dynamic setting depend on its actual market share, the relevant redemption rate of its targeted promotions, the value of its market share increase, and the effectiveness of its targeted promotions. Optimal targeting strategies call for a firm to increase its expenditure on defensive (offensive) targeting relative to offensive (defensive) targeting, thus focusing more on customer retention (customer switching), when its market share becomes larger (smaller). These optimal strategies have the attractive feature of being an adaptive control rule. A firm can operationalize these strategies by adjusting its planned promotional incentives on the basis of the observed differences between actual and planned market shares and between actual and planned redemption rates. In the long run, a focus on customer retention is not an optimal strategy for all firms. A firm with a sufficiently large market share should stress customer retention, whereas a firm with a small market share should stress customer acquisition. When market shares are more evenly divided in a market, firms are better off in the long run if they all focus on customer acquisition. Our analysis also suggests that to build a long-run market share advantage in the age of information-intensive marketing, a firm must strive to improve its targeting effectiveness and increase its unit profit margin. We illustrate the results through a numerical example and show the trajectories of a firm's market share, promotional expenditures, and profits as competing firms use targeted promotions optimally over time.
JEL Classification: L21, L15
Suggested Citation: Suggested Citation