Comment on “On Estimating Current-customer Equity Using Company  Summary Data”

Comment on “On Estimating Current-customer Equity Using Company Summary Data”

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Available online at www.sciencedirect.comJournal of Interactive Marketing 25 (2011) 18–19www.elsevier.com/locate/intmarComment on “On Estimating Current-customer Equity Using CompanySummary Data”a, b⁎Peter S. Fader & Bruce G.S. HardieaWharton School of the University of Pennsylvania, 749 Huntsman Hall, 3730 Walnut Street, Philadelphia, PA 19104-6340, USAbLondon Business School, UKInthispaperPhilPfeiferpresentsanapproachforestimating tenure with the firm increases. This is routinely observed bycurrent-customerequityusingcompany-reportedsummarydata managersofsubscription-basedbusinessessuchasNetflix(whichwhen the reporting period spans multiple renewal periods. We isthefocalcompanyforPfeifer'sanalysis):“Newsubscribersaresincerelyadmireanumberofaspectsofthepaper,including:(1) actually more likely to cancel their subscriptions than olderitsfocusonaproblemofgenuinemanagerialinterest,(2)itsuse subscribers, and therefore, an increase in subscriber age helpsofa“realworld”datasetcoveringalengthyperiodoftime(and overallreductionsinchurn” (Netflix,Inc.2006).the author's decision to publish the full dataset in the paper, Unfortunately,theaggregateretentionratenumbersreportedwhichfacilitatesfuturere-analysesofit),and(3)itsaimtobring by such companies (and by Pfeifer) hide this important patternclarity (and methodological improvement) to approaches used and merely reflect a weighted average of the retention ratesin earlier papers while still retaining a highly ...

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Available online at www.sciencedirect.com
Journal of Interactive Marketing 25 (2011) 1819
www.elsevier.com/locate/intmar
Comment onOn Estimating Currentcustomer Equity Using Company Summary Dataa, b Peter S. Fader& Bruce G.S. Hardie a Wharton School of the University of Pennsylvania, 749 Huntsman Hall, 3730 Walnut Street, Philadelphia, PA 191046340, USA b London Business School, UK
In this paper Phil Pfeifer presents an approach for estimatingtenure with the firm increases. This is routinely observed by currentcustomer equity using companyreported summary datamanagers of subscriptionbased businesses such as Netflix (which when the reporting period spans multiple renewal periods. Weis the focal company for Pfeifer's analysis):New subscribers are sincerely admire a number of aspects of the paper, including: (1)actually more likely to cancel their subscriptions than older its focus on a problem of genuine managerial interest, (2) its usesubscribers, and therefore, an increase in subscriber age helps of areal worlddataset covering a lengthy period of time (andoverall reductions in churn(Netflix, Inc. 2006). the author's decision to publish the full dataset in the paper,Unfortunately, the aggregate retention rate numbers reported which facilitates future reanalyses of it), and (3) its aim to bringby such companies (and by Pfeifer) hide this important pattern clarity (and methodological improvement) to approaches usedand merely reflect a weighted average of the retention rates in earlier papers while still retaining a highly practicalacross all cohorts at any given time (i.e., a mix ofyoungand perspective on the problem at hand.oldcustomers). This weighted average will mask (and The accomplishment of such goal inevitability involvesmoderate) the withincohort retention patterns, potentially tradeoffs; without access to the more disaggregated datagiving the analyst the impression that the retention dynamics lurking in the firm's customer databases, we cannot buildare mild (and therefore possibly ignorable). models of a richness desired by many of our academicIs this the casecan weassume awaythe withincohort colleagues. Whenever undertaking such an exercise, we alwaysretention dynamics as a minor source of noise? The answer is keep in mind a saying attributed to Albert Einstein:Make absolutelynot. Building on earlier work published in this everything as simple as possible, but not simpler.So while wejournal (Fader and Hardie 2007a), we have shown how failing like what Pfeifer has tried to achieve, we feel that the approachto account for cohortlevel retentionrate dynamics will lead to presented in this paper has overstepped the mark: it isbiased estimates of the residual value of atoo systematically simpleto properly address the problems it aims to deal with.customer (and therefore equivalent biases in what this paper One key assumption in this work, which is shared by virtuallycalls currentcustomer equity (CCE)). Our analysis (published all other papers in thevaluing customers/customer equityinFader and Hardie 2010) shows that valuations performed literature (e.g.Gupta and Lehmann 2003; Gupta, Lehmann, andusing an aggregate retention rate will underestimate the true Stuart 2004; Libai, Muller, and Peres 2009; Wiesel, Skiera, andvalue of the customer base by a magnitude of 25%50% in Villanueva 2008), is that of aconstant retention ratestandard settings. Any analysis designed to estimate CCE must. Unfortu nately this is not what we observe in real data. If we look at abe based off an underlying model of customer behaviour that cohort of customers acquired at a particular point in time, wecaptures the cohortlevel retentionrate dynamics, such as the (almost) always observe increasing retention rates as the cohort'sshiftedbetageometric (sBG) model presented inFader and Hardie (2007a)or the gamma mixture of Weibulls as used by Schweidel, Fader, and Bradlow (2008). To be fair, Pfeifer acknowledges the desirability of such an approach but stops well Corresponding author. short of incorporating anything like it into his proposed method Email addresses:faderp@wharton.upenn.edu(P.S. Fader), forfinetuningthe retention rates. bhardie@london.edu(B.G.S. Hardie). Perhaps one reason why he (and other researchers) chose not URLs:http://www.petefader.com(P.S. Fader),http://www.brucehardie.com (B.G.S. Hardie).to capture these retentionrate dynamics is the apparent need for 10949968/$  see front matter © 2011 Direct Marketing Educational Foundation, Inc. Published by Elsevier Inc. All rights reserved. doi:10.1016/j.intmar.2010.12.001
P.S. Fader, B.G.S. Hardie / Journal of Interactive Marketing 25 (2011) 1819
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longitudinal data for each cohort in order to estimate thedataset in order to obtain the estimates of future customer parameters of the duration model. However, as we show inequity, which is an important component of many of the Fader and Hardie (2007b)aforementioned, this need not be the case. In fact,customer equitypapers. under certain assumptions, all we require are data on the numberThus Pfeifer's effort tofinetunethe retention rates in a of new subscribers and the total number of subscribers for eachrealistic setting is a wellintended exercise, but it falls short of period. itspotential since it ignores cohortlevel retention dynamics. An important requirement of this estimation approach is thatFortunately, thefixthat we have briefly outlined here still we must have such data for each renewal period from the timequalifies assimple(but nottoo simple), and it offers a the service of interest was launched on the market. The Netflixnumber of other managerial benefits as well. The key point is dataset used in Pfeifer's paper does not satisfy this requirement:that one needs not rely on oversimplified assumptions about the data series is left censoredwe see 603,000 customers atcustomer behaviour in order to offer practical solutions to the beginning of Q2/2002 but we don't know how old they are.important managerial problems. Telling the rightstory(and This is a nonissue when we assume a constant retention rateusing appropriate mathematical constructs to implement it) can (and Pfeifer never comments on it). However, it becomes abe simple and highly effective at the same time. There will problem when we choose to acknowledge the reality of thealways be tradeoffs when building a model, but researchers retentionrate dynamics. Some of these older customers mayshould always strive to find the best balance in dealing with still bealivewhen we stand at the end of Q1/2009 and attemptthem. to compute CCE. It is important that we account for the fact that some of them will have been acquired in, say, Q1/2000 while others in Q1/2002the former group will be further out on the References retentionrate curve and therefore have a higher residual lifetime value than the latter. Fader, Peter S. and Bruce G.S. Hardie (2007a),How to Project Customer There is a reasonably straightforward solution to this Retention,Journal of Interactive Marketing, 21, 7690 (Winter). problem: the analyst only needs to fit a model of customer———and———(2007b),Fitting the sBG Model to MultiCohort Data,http://brucehardie.com/notes/017/. Retrieved September 20, 2010. acquisition to the observedadditionsdata, thenbackcastthe ———and———(2010),CustomerBase Valuation in a Contractual additions past the point of left censoring, all the way back to the Setting: The Perils of Ignoring Heterogeneity,Marketing Science, 29, launch of the service. A variety of customer adoption models 8593 (JanuaryFebruary). (such as the Bass model) can be used for this procedure, and the Gupta, Sunil and Donald R. Lehmann (2003),Customers as Assets,Journal of data are readily available in Pfeifer's paper.Interactive Marketing, 17, 924 (Winter). ———,———, and Jennifer Ames Stuart (2004),Valuing Customers,Once this adoption model has been estimated, it can be used Journal of Marketing Research, 41, 718 (February). to provide a simple and effective alternative methodology to the Libai, Barak, Eitan Muller, and Renana Peres (2009),The Diffusion of main contribution that Pfeifer offers in his paper: one can easily Services,Journal of Marketing Research, 46, 16375 (April). interpolate from the quarterly acquisition numbers down to the Netflix, Inc.,10K for the Fiscal Year Ended December 31, 2005. Retrieved monthly level. From there, it is a straightforward (albeit tediousSeptember 20, 2010 from EDGAR Database. Schweidel, David A., Peter S. Fader, and Eric T. Bradlow (2008), accounting) exercise to extend theCase 2estimation Understanding Service Retention Within and Across Cohorts Using approach outlined inFader and Hardie (2007b)to compute CCE Limited Information,Journal of Marketing, 72, 8294 (January). using the expressions for a customer's residual lifetime value Wiesel, Thorsten, Bernd Skiera, and Julian Villanueva (2008),Customer presented inFader and Hardie (2010). Furthermore, one can Equity: An Integral Part of Financial Reporting,Journal of Marketing, 72, project the adoption model beyond the bounds of the observed114 (March).