CUSTOMER LIFETIME VALUE, CUSTOMER PROFITABILITY AND THE TREATMENT OF ACQUISITION SPENDING

Schultz addressed the importance of good definitions in an editorial calling on marketing academics and practitioners to define direct marketing. If we don't [establish precise definitions], I fear we will find that what you are talking about when you say direct marketing may have absolutely no relationship to what I consider direct marketing. And, for an academic discipline, that is the worst of all possible worlds (1995: 9). Whereas the confusion in 1995 was over the meaning of direct marketing, we believe there is an unhealthy amount of confusion today over the meanings of two of the most important terms in interactive marketing: customer lifetime value and customer profitability. The terms customer lifetime value and customer profitability are important to interactive marketing because they are both used to talk about and measure customer differences. As Peppers and Rogers stated, "some customers are more equal than others," and firms can prosper by learning how to "identify and capitalize on customer differences" (1997: 30). Given the importance to interactive marketing of recognizing customer differences, it is critical to use precise language to talk about those differences and thereby avoid Schultz's "worst of all possible worlds. " Instead of using precise language when discussing customer differences, however, it appears some researchers are doing just the opposite. In a recent article surveying customer profitability measurement and research, Mulhern (1999) lists seven terms the literature uses to refer to customer profitability. Customer lifetime value is included in the list. Mulhern goes on to use the two terms interchangeably. His "general formulation for customer lifetime value" is an equation with a left-hand-side variable defined as "the profit of customer i to the firm" (1999: 30). So clearly, Mulhern sees no difference in the meanings of customer lifetime value and customer profitability. The purpose of this article is to improve the precision of our language in this area by focusing on the difference between customer lifetime value and customer profitability. If you agree with Mulhern (1999) that there is no difference in the meaning of these two terms, then our purpose is to create a difference. If you are uncertain of the difference between the meanings of these two terms, then our purpose is to attempt to clarify the difference for you. Finally, if you have a clear understanding of the differences in meanings, our purpose is to verify that we share the same understanding. As an example of how imprecise language has led to confusion in this area, consider how Heskett, Sasser, and Schlesinger describe the results of an important study conducted by Reichheld and Sasser (1990): . a 5 percentage point increase in average customer retention of credit card customers . would increase a credit card service company's profits by 75 percent (1997: 61). This statement suggests that the 75% increase reported by Reichheld and Sasser applies to company profits. However, a careful reading of Reichheld and Sasser (1990) shows that the reported increase refers instead to "customer value," described by Reichheld and Sasser as "the net present value of the profit streams for the average customer life" (1990: 110). Contributing to the confusion is the title of the main chart in the Reichheld and Sasser article: "reducing defections 5% boosts profits 25% to 85%" (1990:10). "Customer value," "net present value of profit streams," and "profit" were all used to label the same metric, leading others to misinterpret the metric as referring to company profits. As another example of confusion, we point to the discussion in Jain and Singh (2002) of whether acquisition costs should be included in measures of customer lifetime value. Jain and Singh argue that acquisition costs should be included in customer lifetime value and suggest that Berger and Nasr (1998) are incorrect to leave them out "in order to get their interpretation" of customer lifetime value as "the maximum profitable acquisition cost" (2002: 16). …