A modified Pareto/NBD approach for predicting customer lifetime value

Authors:
Nicolas Glady;Bart Baesens;Christophe Croux
Affiliations:
Faculty of Business and Economics, K.U. Leuven, Naamsestraat 73, 3000 Leuven, Belgium;Faculty of Business and Economics, K.U. Leuven, Naamsestraat 73, 3000 Leuven, Belgium and School of Management, University of Southampton, Highfield, Southampton SO17 1BJ, United Kingdom;Faculty of Business and Economics, K.U. Leuven, Naamsestraat 73, 3000 Leuven, Belgium
Venue:
Expert Systems with Applications: An International Journal
Year:
2009

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Abstract

Valuing customers is a central issue for any commercial activity. The customer lifetime value (CLV) is the discounted value of the future profits that this customer yields to the company. In order to compute the CLV, one needs to predict the future number of transactions a customer will make and the profit of these transactions. With the Pareto/NBD model, the future number of transactions of a customer can be predicted, and the CLV is then computed as a discounted product between this number and the expected profit per transaction. Usually, the number of transactions and the future profits per transaction are estimated separately. This study proposes an alternative. We show that the dependence between the number of transactions and their profitability can be used to increase the accuracy of the prediction of the CLV. This is illustrated with a new empirical case from the retail banking sector.