The Long-Term Impact of Sales Promotions on Customer Equity

Transcription

1 The Long-Term Impact of Sales Promotions on Customer Equity Author: HERBERT CASTERAN - herbert.casteran@em-strasbourg.eu University: EM STRASBOURG BUSINESS SCHOOL Track: Advertising, Promotion and Marketing Communications Co-author(s): Polymeros Chrysochou (Aarhus University) / Lars Meyer-Waarden (EM Strasbourg Business School & IAE Toulouse) Access to this paper is restricted to registered delegates of the EMAC 2014 Conference.

2 The Long-Term Impact of Sales Promotions on Customer Equity Abstract Sales promotions effectiveness for short-term sales is proven. However, for long-term sales, possible adverse effects have been suggested. To bridge this gap, we apply stochastic models (BG/NBD model) in 74 packaged good categories of a Danish consumer panel and measure the cumulated long-term effects of promotions at the customer portfolio level by computing purchase frequencies, attrition and customer equity. Promotions have a mitigated impact: while the effect on purchase frequencies is overall positive, the impact on retention and lifetime duration is only positive in half of the categories. Finally, the effect on customer equity is positive in 62% and negative in 38% of the product categories analyzed. Keywords: customer equity, customer lifetime value, customer portfolio management, sales promotions, marketing efficiency. Track: Advertising, Promotion and Marketing Communications 1

3 1. Introduction An increasing number of retailers switch from a promotional pricing strategy (HiLo) to an everyday low pricing strategy (EDLP; Dale, 2012). This illustrates the managers increasing scepticism concerning sales promotions. Despite their proven effectiveness for short-term sales (Blattberg & Neslin, 1990), on the long-term earlier literature has identified adverse effects, however without managing to determine their actual impact (van Heerde et al., 2004). Moreover, consumers are overwhelmed by non-stop promotional flows. The effect must therefore not be assessed in an isolated manner, but it should take into account these multiple solicitations. Furthermore, the measurement unit of the promotional impact should be taken into consideration. While most investigations analyze the effects of promotions on sales, it is important to consider the global impact, on the customer portfolio and customer equity (CE). The customer acquisition effect is well documented as price promotions attract new customers (Villanueva et al., 2008). Whatever the value of the new customers, the global value of the portfolio increases. The main issue thus resides on the value of existing customers. This research contributes by establishing a long-term vision of the impact of promotions on the value of existing customer portfolio (CE), and not only on sales. To do so, we combine explanatory and stochastic modeling approaches. An additional contribution of this paper is the application of these models to packaged goods, a sector which has thus far been overlooked by existing research. 2. Conceptual Framework and Hypotheses 2.1. Customer portfolio, customer equity and customer lifetime value The total asset value of a customer portfolio is the customer equity (CE) that is defined as the sum of a company s current and potential customers lifetime value (Rust et al., 2004; Gupta et al., 2006). Customer lifetime value (CLV) is the value of a customer relationship, based on the past, present and projected future cash flows from this relationship. The customer portfolio, CLV and CE are important concepts on which the customer relationship management strategy and the assessment of the marketing efficiency are based on. Such as strategy encourages firms to shift focus from short-term profits to long-term client relationships. Customers represent assets and the cost of acquiring them relates to the cash flow they are expected to generate over time (Tarasi et al., 2011). The link between CE, acquisition and retention is evident (Schulze et al., 2012; Wiesel et al., 2008), and customer portfolio decisions are part of a high-risk and complex marketing investment framework, created to enhance the value of brand and customer assets via marketing actions, such as promotions The long term impact of sales promotions on customer equity If the positive effects of promotions (e.g. price reductions, coupons, vouchers, aisle end displays) are well established with regard to increasing sales in the short-term (Blattberg & Neslin, 1990), the long-term effects are less clear. On the one hand, there is ample evidence in the literature of the negative consequences of promotions in the long run (Mela et al. 1997; Jedidi et al., 1999). On the other hand, since the 2000s, the long-term harmlessness of sales promotions is progressively being established (Slotegraaf & Pauwels, 2008). This change of vision is first linked to the level of analysis, since literature increasingly considers the global effect of promotions (Slotegraaf & Pauwels, 2008) by considering their succession and effects 2

4 on customers and non-customers. The second point is the measurement unit that has been considered. Earlier literature approaches the effects of promotions from the viewpoint of sales, which makes it impossible to determine whether the promotion ultimately creates value or not. A solution to this problem is by the use of a global metric with CE being one recommended (van Heerde et al., 2004), since it captures all stages of customer life cycle (acquisition, activity and retention). The modeling of the effect promotions have on CE must therefore include all these stages of consumers life cycles and associated measures such as brand switch and purchase frequency (i.e. number of times a customer purchases a specific brand during a certain period) as well as attrition probability (the probability a customer to stop purchasing a specific brand). Two immediate positive effects are associated with a promotion (Blattberg & Neslin, 1990): a switch to the promoted brand with an acceleration of its purchase frequency. These effects should also be observed on the long run by considering the multiple successions of promotional flows. We therefore hypothesize: H 1 : Sales promotions have a positive long-term impact on a brand s purchase frequency. Regardless of the theory invoked (e.g. framing, attribution, promotional signal, reference price theory) there is every reason to consider sales promotions as ways of stimulating purchase. Sales promotions can indirectly reduce procedural costs and perceived risk, due to their informational content. The actual question that still remains is to know which type of customer is recruited. The succession of promotions runs the risk of reducing willingness to pay and eroding sensitivity to promotions (Dekimpe & Hanssens, 1995). These discount customers, not particularly attracted to the brand, benefit from temporary price reductions via brand switching as well as temporary, non-durable purchases. Despite an increasing number of new customers, their declining value is the key to their future behavior. Furthermore, no switching costs exist and customers can switch to other promoted brands without any limits. In the long run, this can undermine positive effects and decrease loyalty (retention probabilities and residual lifetime durations, defined as the expected future lifetime durations for existing customers; Jedidi et al., 1999; Mela et al., 1997). We hypothesize: H 2a : Sales promotions have a negative long-term impact on a brand s customer retention probabilities. H 2b : Sales promotions have a negative long-term impact on a brand s customer residual lifetime durations. Sales promotions have a dual impact on the value of existing customers. The first impact relates to the customers activity until they defect. Regardless of the theory invoked (e.g. framing, attribution, promotional signal, reference price theory) sales promotions stimulate purchase frequency of existing customers. While sales promotions generate a drop in the unit price, the increase in the volume sold offsets this price reduction. We can therefore expect an overall positive cumulated effect on the average expenditure in favour of the brand. However, in the long run, considering the aggregated effects on the customer portfolio, the negative effects on customer attrition described above (e.g. relating to opportunism, brand switching, increased sensitivity to price, decrease of the reference price, eroding impact of promotional effects over time) might undermine positive effects of purchase frequencies and decrease the global CE (Jedidi et al., 1999; Mela et al., 1997). We thus hypothesize: H 3 : Sales promotions have a negative long-term impact on existing customer equity (CE). 3

5 3. Methodology 3.1. Data We use data from the GfK consumer panel data in Denmark. The panel includes approximately 2,500 households and is geographically and demographically representative of the Danish consumer population. We consider data that cover purchases for a period of 5 years (2006 to 2011) across 74 fast moving consumer good (FMCG) categories. During this period there were 4,572 unique households (every year the panel is updated) that made 5,727,768 transactions in total out of 38,026 different SKU codes. Sales promotions are price cuts and coded as dummy variables Modeling the impact of promotions To test the impact of promotions we take into account two indicators: the purchase frequency for a given period and customer loyalty measured through its lifetime duration. Those indicators allow the estimation of the global expected residual transactions DERT(t). For the modeling of expected residual transactions, we use the BG/NBD (Abe, 2009a; Fader et al. 2005a) and introduce explanatory variables (Fader & Hardie, 2007). The number of purchases Y follows a Poisson distribution with a transaction rate λ. Heterogeneity across customers is represented by the gamma distribution of λ with parameters r (shape) and α (scale). The customer has a fixed probability p to become inactive immediately after any repeat transaction. This probability is then geometrically distributed, and heterogeneity in p is modeled with a more flexible beta distribution with parameters a and b. Nevertheless, the probability p of becoming inactive after any transaction and the transaction rate λ vary independently across customers. Fader et al. (2005) suggest a link between dropout probability and inactivity, Ε (τ λ, p )= 1 λp (1) with τ date of inactivity. This formula can be viewed as an effect of exhaustion. Thus, an increase of repeat purchases induces a lower lifetime duration. We can thus identify the impact on the expected purchase frequency λ and the expected probability to become inactive E (p) (Fader et al., 2005b). z is the number of price promotions and γ 2 the coefficient values: α = α 0 exp(-γ 1 z), a = a 0 exp(γ 2 z) and b = b 0 exp(γ 3 z). The expected purchase frequency is: Ε ( λ)= r α (2) The expected probability to become inactive after a repeat purchase: Ε ( p )= a a+b (3) The inactivity of a given customer may occur only after the first repeat purchase, such that until a customer makes a transaction she/he is considered active. The model thus leads to the assumption that customer dropout occurs only after a transaction, such that customers with zero repeat purchases during the observation period appear active at time T and thereafter, until they make a transaction. The model is estimated on the SKU level for each category on a weekly basis over the period of five years. 4

6 4. Analysis and Results The BG/NBD model with explanatory variables is considerably more efficient (average absolute BIC = 110,583) than the basic BG/NBD model (BIC = 436,827). Table 1 presents a summary of the results from the model estimations on each indicator. The effect of sales promotions on purchase frequency E(λ) is positive for all product categories analyzed. In the case of retention probabilities after each repeat purchase E(p), promotions show a significant positive effect in 48.7% of the product categories analyzed and no effect in the remaining ones (51.3%). On the other hand, promotions increase in 62.2% the overall customer lifetime duration E(τ), but do reduce it in 37.8 of the categories. Finally, sales promotions show a significant positive effect on CE in 62.0% of the product categories, whereas they negatively impact the remaining 38.0%. Table 1: Effect of sales promotions on purchase frequency, retention probability, lifetime duration and customer equity Indicator Percent (%) of product categories with a significant positive effect no effect a significant negative effect Purchase frequency E(λ) Retention probability after each repeat purchase E(p) Residual lifetime duration E(τ) Customer equity (CE) Discussion, implications and future research directions Our study contributes to the existing literature in several ways. The high number of categories tested ensures a high external validity of our results. Sales promotions have more positive than negative long term impact on existing customer equity. But the results are category specific. We do not have a specific explanation for the differentiated impact of sales promotions on retention or loyalty. Our conclusions on the efficiency of promotions are slightly different from existing literature. First, promotions have overall a long term positive effect in many cases, contrary to a large portion of literature (e.g. Jedidi et al., 1999; Mela et al., 1997). The effect is positive on the customer activity (frequencies). We thus confirm H1, sales promotions have a positive long-term impact on a brand s purchase frequency. Concerning customer retention the impact is globally positive too (as in half of the categories the effect is positive). At worst, there is no impact at all on retention. Sales promotions thus have not a negative long-term impact on a brand s customer retention probability after each repeat purchase. We reject H2a.On the other hand sales promotions have in most cases a positive long-term impact on customer lifetime durations. Nevertheless, in one third of the categories the impact on residual lifetime duration is negative. We thus only partially validate H2b. Finally, promotions have a dual influence on the CE. The impact is positive in the majority of the categories. Nevertheless, in one third of the cases the impact on CE is 5

7 negative. We thus only partially validate H3.Sales promotions thus not necessarily have a negative long-term impact on customer equity (CE). In the categories where the impact is negative, the global effect on existing customers is closely related to the negative impact on lifetime duration. Loyalty or retention appears as the main driver for existing customers value. Promotions there seem to stimulate the purchase frequencies of existing customers. However, if the size of the customer portfolio increases, the value of the newly acquired customers is inferior as the succession of promotions runs the risk of reducing lifetime durations (Dekimpe & Hanssens, 1995). In the long run, considering the aggregated effects on the customer portfolio, these negative effects on customer retention (e.g. relating to opportunism, brand switching, increased sensitivity to price, decrease of the reference price, eroding impact of promotional effects over time) seem undermine positive effects of purchase frequencies and thus decrease the global CE (Jedidi et al., 1999). Another explanation might be related to the suppositions of the BG/NBD model which might not be best adapted to the high purchase frequency rates in grocery retailing. In this case, the assumption that a customer is active until (s)he makes a repeat purchase is a problem. The purchase frequency is too high and affects the dropout time which might cause higher attrition ( exhaustion effect). From a conceptual point of view, we contribute to the literature by introducing explanatory variables into the BG/NBD model which enables marketing researchers to measure the impact of marketing actions, such as sales promotions. Finally, our managerial contribution relates to the fact, that the impact of promotions is mostly not negative on the long term.. Our results here are somewhat reassuring for marketers promotions do not necessarily harm the brand on the long term. Likewise, the results are a counterpoint to the statement that sales promotions are gradually destroying CE over time. Our results support Slotegraaf s and Pauwels s, contention (2008) that this 'value destruction' may be more of a buzz-word than an empirical fact. Our analysis has shown an indication that purchase frequency and retention exhibit in most categories a noticeable upward trend over time. Our research contains several limitations. First, the retail industry is characterized by strong behavioral inertia and the absence of objective switching costs. Second, the magnitude of the promotions is not illustrated by our definition. Finally, the informational prerequisites of NBD models mean that explanatory variables lack a dynamic perspective. The models used are not capable of capturing seasonality: in their native state, the variables are invariant over time. References Abe, M. (2009a). Counting your customers one by one: A hierarchical Bayes extension to the Pareto/NBD model. Marketing Science, 28(3), Abe, M. (2009b). Customer lifetime value and RFM data: Accounting your customers: One by one. Discussion paper CIRJE-F- 616, Graduate School of Economics, The University of Tokyo, Tokyo. Blattberg, R. C., Briesch, R., & Fox, E. (1995). How promotions work. Marketing Science, 14(3), Blattberg, R. C., & Neslin, S. (1990). Sales Promotion, Concepts, Methods and Strategies. Englewood Cliffs, NJ: Prentice Hall. Bucklin, R. E., & Lattin, J. (1991). A two-state model of purchase incidence and brand choice. Marketing Science, 10(1), Chandon, P., Wansink, B., & Laurent, G. (2000). A benefit congruency framework of sales promotion effectiveness. Journal of Marketing, 64(4),

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