Customer lifetime valuation using real options analysis

Abstract

As the concept of Customer Lifetime Value (CLV) is gaining a growing acceptance to achieve superior efficiency and effectiveness of marketing plans, development of more accurate models to measure CLV is becoming an important issue. Most CLV models cannot consider the management flexibility in uncertain situations. Real options valuation is the approach in such situations. This article aims to provide models to measure CLV using real options valuation. The research firstly aims to identify major options a seller has in relationship with its customers. Then, we focus on development of models to measure options’ values for better estimation of CLV. In this research, we develop three models based on real options. Each model is useful when the following options are available: option to market penetration, option to customer development through add-on selling and option of stage investment. The applicability of the models is demonstrated by numerical illustrations. Results show the classical models of CLV measurement ignore the value of options despite the fact that sometimes these options have considerable values and are decisive in managers’ decision making.