Mel Lazo ISDS 7540 Marketing Analytics Module Dr.

Black 7 December 2012

Pilgrim Bank Case Analysis

Introduction and Defining the Relationships
The business analyst at Pilgrim Bank, Alan Green, was tasked with guiding the marketing team to a better understanding of customer profitability. With the help of his supervisor and the IT department, he has access to an extensive data set of over 30,000 customers, both old and new. Included are continuous variables for Profit, Tenure, and Satisfaction, categorical variables for Age buckets and Income buckets, and indicator variables for Online customers and BillPay users. In particular, Pilgrim Bank wants to understand the dynamics of profit between Online uses and non-users. For both years, 1999 and 2000, the Online customers had the greatest average profit; also there was an increase in the number of Online customers:
Table 1 - Summary Statistics by Online Users N Sum _9Online 0 23167 $3,317,624.00 1 3305 492,721.00 _0Online 0 21582 $3,364,815.77 1 4890 889,556.25 Mean $143.20 149.08 $155.91 181.91

_9Profit

_0Profit

Though the difference was not significant in 1999, it did turn out to be significant in the year 2000, probably from the increase in users. In fact, the total Profit from Online customers almost doubled since 1999. On the surface, banking online does seem to drive profitability, or at least, should be reason to explore the relationship further.

Lazo 2 In order to explain the relationship between a customer and his/her profit, I have decided to view it in the frame of Regression Equations. If we find significant predictors of profitability, it could shed light on factors the marketing team should focus on to attempt and boost annual profit for the bank. For a very holistic, simplified view of this relationship, we can consider to following regression type relationship:

The idea of building this regression model is for the purpose of explanation more than prediction. We want to be able to explain what drives profitability.

First Attempts at Building Regression Equations

We start off trying to explain the drivers of profitability for the year 1999 with a very simple Linear Regression Model using all demographic variables as inputs, including whether the customer was an Online user and if they used Pilgrims online BillPay service. What we get is the following equation:
Table 2 - Regression Attempt 1 Parameter Estimates Standard t Value Pr > |t| Standardized Error Estimate 8.20464 25.62 <.0001 0 0.19339 24.33 <.0001 0.14580 4.90624 1.24 0.2148 0.00730 12.33194 6.21 <.0001 0.03595 9.50968 -13.45 <.0001 -0.08596 6.31466 -15.50 <.0001 -0.13162 5.83169 -11.40 <.0001 -0.10303 5.73240 -10.75 <.0001 -0.09474 6.13626 -8.98 <.0001 -0.07046 6.61121 -6.57 <.0001 -0.04735 6.77793 -20.86 <.0001 -0.14442 8.72475 -15.11 <.0001 -0.09330 6.30987 -20.62 <.0001 -0.14637 6.41004 -19.08 <.0001 -0.13448 6.24952 -18.95 <.0001 -0.13485 5.30562 -19.80 <.0001 -0.16082 5.88306 -13.07 <.0001 -0.09609 6.68042 -10.50 <.0001 -0.07093 6.23518 -1.53 0.1272 -0.01043 4.45269 2.88 0.0040 0.01978

Variable Intercept _9Tenure _9Online _9Billpay Age1 Age2 Age3 Age4 Age5 Age6 _9Inc1 _9Inc2 _9Inc3 _9Inc4 _9Inc5 _9Inc6 _9Inc7 _9Inc8 _9District1 _9District2

DF 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

Parameter Estimate 210.17371 4.70558 6.08570 76.56223 -127.89911 -97.84704 -66.46178 -61.62295 -55.11275 -43.41115 -141.37783 -131.83197 -130.12630 -122.32853 -118.43921 -105.06792 -76.90923 -70.12753 -9.51036 12.81120

95% Confidence Limits 194.09230 4.32652 -3.53073 52.39115 -146.53845 -110.22402 -77.89211 -72.85868 -67.14005 -56.36939 -154.66284 -148.93283 -142.49389 -134.89247 -130.68851 -115.46714 -88.44025 -83.22141 -21.73156 4.08376 226.25513 5.08463 15.70212 100.73330 -109.25977 -85.47007 -55.03144 -50.38722 -43.08544 -30.45291 -128.09282 -114.73111 -117.75871 -109.76459 -106.18990 -94.66870 -65.37820 -57.03365 2.71084 21.53865

Lazo 3 The above regression equation is showing us how profitability changes based on the difference groups represented by the reference indicator variables. Interpreting these standardized regression coefficients for demographics, we can see for age bins 2 and 3, profitability went down when compared to the other groups and the higher age bins were a bit more profitable. With income, bins 2, 7, 8, and 9 were more profitable than the more moderate income levels. And finally, we can see that District 1200 was significantly higher than the other two Districts. Notice, also, that being an Online customer was not significant in driving profitability where BillPay was. For the year 1999, Online may not have been a well-used channel, and with the old channels still in place, any profit it may have brought in was insignificant. Since BillPay users did have higher profitability, those Online users were at least profitability drivers.
Table 3 - Summary Statistics by BillPay N Sum _9Profit _9Billpay 0 25993 $3,703,783.00 1 479 106,562.00 _0Profit _0Billpay 0 25696 $4,050,193.81 1 776 204,178.21 Mean $142.49 222.47 $157.62 263.12

We can see the same near doubling of average and total profit from 1999 to 2000 when looking at customers that participate in the BillPay service. In the next year, can Online banking bring in more profitability if the company focuses on getting customers to use the Online channel more while also getting them to sign up for online BillPay services? Despite the Y2K Computer Bug, you can see above that online BillPay users still increased. We can look at regression for the year 2000 to see if Online profitability changed.

Regression for the Year 2000

I essentially took the same approach for building a regression model as for the year 1999. The result is an equation with the following parameter estimates:

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Variable Intercept _0Tenure _0Billpay _0Online _0Inc1 _0Inc2 _0Inc3 _0Inc4 _0Inc5 _0Inc6 _0Inc7 _0Inc8 _0District1 _0District2

DF 1 1 1 1 1 1 1 1 1 1 1 1 1 1

Parameter Estimate 189.69404 5.56260 93.42847 10.68698 -144.46883 -149.00213 -138.86467 -129.28915 -137.17443 -112.18356 -86.95093 -71.23746 -11.35075 5.93722

Table 4 - Regression Model for Year 2000 Parameter Estimates Standard t Value Pr > |t| Standardized Error Estimate 7.83270 24.22 <.0001 0 0.21398 26.00 <.0001 0.15645 11.67332 8.00 <.0001 0.05145 5.10814 2.09 0.0364 0.01354 8.44817 -17.10 <.0001 -0.12605 10.92482 -13.64 <.0001 -0.09116 7.75284 -17.91 <.0001 -0.13603 7.84492 -16.48 <.0001 -0.12547 7.62121 -18.00 <.0001 -0.13892 6.42166 -17.47 <.0001 -0.15309 7.10728 -12.23 <.0001 -0.09797 8.05632 -8.84 <.0001 -0.06546 7.82544 -1.45 0.1469 -0.01093 5.55147 1.07 0.2849 0.00810

95% Confidence Limits 174.34152 5.14318 70.54813 0.67476 -161.02770 -170.41537 -154.06065 -144.66560 -152.11241 -124.77036 -100.88158 -87.02828 -26.68905 -4.94395 205.04656 5.98202 116.30881 20.69921 -127.90996 -127.58889 -123.66870 -113.91269 -122.23646 -99.59676 -73.02028 -55.44664 3.98754 16.81840

We can see that the effects of the demographic variables were relatively the same, but now Online users were positively significant in profitability. So gathering these two explanatory regression models, I would recommend to the marketing team that there are huge profit opportunities in the online banking area to warrant incentive programs for customers to become Online users and take advantage of the BillPay service. However, only a small percentage (about 4%) of customers switched from non-Online user to Online user in that year so there may be roadblocks to getting customers to switch. We can imagine younger customers being more receptive to online banking and utilizing online BillPay services, so getting new customers to sign up for online banking from the very beginning may yield higher profitability.

Factoring in Customer Relationships

Of the two models detailed above, neither had a high Adjusted R2 value, indicating a less than perfect fit. We can account much of this imperfection in the very nature of real-life data, non-normality, and heteroscedasticity, however, we can look at one factor not yet used in the equation that may be of

Lazo 5 interest to the marketing team: customer relationship. Can we improve the above models if we include information about the loyalty and satisfaction of Pilgrims customers? In order to address this question, we have been given the results of a satisfaction survey given to customers in 1999 with the variable _9Satisfaction. We will include this variable into the 1999 regression model and see if there is an improvement in model fit.
Table 5 - Regression with _9Satisfaction Parameter Estimates Parameter Standard t Value Pr > |t| Standardized Estimate Error Estimate -366.64704 8.82937 -41.53 <.0001 0 -5.32432 0.18985 -28.04 <.0001 -0.16497 14.31780 0.13298 107.67 <.0001 0.65610 1.99752 4.19698 0.48 0.6341 0.00239 56.01744 10.55049 5.31 <.0001 0.02630 20.13136 8.24997 2.44 0.0147 0.01353 14.45498 5.50135 2.63 0.0086 0.01944 21.73977 5.05526 4.30 <.0001 0.03370 5.35027 4.94281 1.08 0.2791 0.00823 -4.01445 5.27038 -0.76 0.4462 -0.00513 -13.31319 5.66215 -2.35 0.0187 -0.01452 19.63091 5.98761 3.28 0.0010 0.02005 16.18519 7.58874 2.13 0.0329 0.01145 -0.13379 5.53086 -0.02 0.9807 -0.00015050 -14.76600 5.57343 -2.65 0.0081 -0.01623 -22.48079 5.41964 -4.15 <.0001 -0.02560 -30.14633 4.59148 -6.57 <.0001 -0.04614 -30.00363 5.05121 -5.94 <.0001 -0.03749 -40.37815 5.72112 -7.06 <.0001 -0.04084 -4.66988 5.33378 -0.88 0.3813 -0.00512 12.36570 3.80884 3.25 0.0012 0.01909

Variable Intercept _9Tenure _9SATISFACTION _9Online _9Billpay Age1 Age2 Age3 Age4 Age5 Age6 _9Inc1 _9Inc2 _9Inc3 _9Inc4 _9Inc5 _9Inc6 _9Inc7 _9Inc8 _9District1 _9District2

DF 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

95% Confidence Limits -383.95294 -5.69644 14.05715 -6.22873 35.33806 3.96110 3.67211 11.83127 -4.33782 -14.34460 -24.41123 7.89497 1.31097 -10.97450 -25.69015 -33.10349 -39.14580 -39.90419 -51.59178 -15.12429 4.90022 -349.34113 -4.95220 14.57845 10.22377 76.69682 36.30163 25.23785 31.64827 15.03837 6.31570 -2.21515 31.36685 31.05941 10.70691 -3.84185 -11.85809 -21.14686 -20.10307 -29.16453 5.78454 19.83118

With the inclusion of _9Satisfaction in the model, we see that the Adj. R2 fit statistic increased from .0704 to .3198, a relatively drastic boost in model fit. Including a satisfaction score for the year 2000 would most likely yield a similar boost in Adj. R2. With this boost in fit, we also see the patterns in the demographic variables have changed. Younger- to moderately-aged customers were more profitable and the higher income levels were not actually as profitable. We also see from the _9Satisfaction estimate that highly satisfied customers significantly contributed to customer profitability. An obvious recommendation would be to increase marketing efforts geared towards increasing customer satisfaction.

Lazo 6 Customer relationship marketing, however, need not stop at understanding profitability. The implications of strong customer relationships point to increased customer loyalty, which is realized now to be equally important to a business as profitability. An understanding of this customer relationship could also shed light on determining customer lifetime value.

Understanding Customer Behaviors

Examining the dataset closely, I noticed that there are many customers that did not have data in the year 2000, signifying that the customers have left Pilgrim Bank. Retention rates have been monitored by businesses extensively to gauge how well the business can attract loyal customers. Upon analysis of the Pilgrim Bank dataset, we can see that from 1999 to 2000, the company has lost 5,162 customers, about a 16.3% churn in this one year. From the information available, I tried to determine the characteristics of customers that churned and those that were retained. Upon analysis, it is easy to see that Pilgrim was able to retain almost 86% of Online customers, and of those, almost 91% of BillPay users were retained. This comparison further advocates for marketing teams to push online initiatives since it has implications for both customer retention and profitability. Running basic t-tests also revealed significant differences in average profit and satisfaction for 1999 for retained customers
Table 6 - Corresponding t-tests by Retained Customers t-test for _9Profit Method Pooled Satterthwaite Var. Equal Unequal DF 31632 21566 t Val. -49.72 -87.23 Pr> |t| <.0001 <.0001 Method Pooled Satterthwaite t-test for _9Satisfaction Var. Equal Unequal DF 31632 8286.3 t Val. -45.59 -51.25 Pr> |t| <.0001 <.0001

These results indicate that retained customers had significantly higher average profits and higher average satisfaction scores, indicating that building strong customer relationships comes from improving customer satisfaction and focusing on the drivers of profitability.

Lazo 7 Another important aspect for Pilgrim Bank to look at in understanding customer behaviors is customer acquisition. Customers interests and needs change over time, so carefully monitoring characteristics of a companys newly acquired customers. Pilgrim Bank has taken on 7,178 new customers in the year 2000. Compared to customers in 1999, these new customers had more online and users on average.
Figure 1 - Online Frequencies between Old and New Customers

With only a two year period, it is hard to see major trends in the use of Pilgrim Banks online services, but at face value, we can see that new customers are more likely to be Online users. Over the next few years, with a solid online initiative from the marketing team, Pilgrim Bank can expect to see increased acquisition and improved customer retention.

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Tying it All Together with Customer Lifetime Value

Together, looking at customer profitability, retention, and acquisition, Pilgrim Bank can begin to look at overall company growth by calculating Customer Lifetime Value (CLV). Conceptually, CLV is the total value that a customer adds to a company. More technically, it is the accumulation of a customers historic transactions and the sum of the customers discounted future cash flows (profits). Much speculation has been put into rigorously calculating CLV, and many different versions exist depending on the nature of the company and its customers. Without intimate discussion of Pilgrim Bank and their operations, it will be difficult to look at CLV at a level higher than just rough estimation. We can, though, establish a framework in the context of the Pilgrim Bank Case Study.
Figure 2 - Customer Lifetime Value Framework

Business Programs

Related Metrics
Customer Retention

Goal

Consequence

Marketing Team and Customer Relationship Program

Customer Acquisition Customer Profitability

Customer LIfetime Value (CLV)

Company Growth

In attempting to estimate CLV calculations, we can look at known CLV calculations and assess the assumption used in calculation.

The above calculation assumes constant margin (profit), mj and retention rate, r. Practically, those numbers will vary each year, and calculations would be made on that basis. Also, we can imagine

Lazo 9 the discount rate, I, to change over time. As such, this equation is rather simplistic. You will also notice the time index, Tj, which also plays into the calculation assumptions. Ease of calculation, there has been instances that this index could be an expected lifetime of a customer, a very large number to estimate infinity, or infinity itself. The choice of which to use is up to the company and how they want CLV calculated. It is also important to note that this equation does not factor in customers historical values, another important part of the CLV calculation. According to a paper by Gupta and Lehmann (2005), using the expected customer lifetime can over shoot the true value of this equation, and thus, using infinity would be the best method. Using a bit of calculus and algebraic manipulation, you can see that:

for Tj . Using this version of the CLV calculation, we can assess Pilgrim Banks company value by Online users and see yet again the value of marketing online services:
N _9CLV _9Online 0 1 _0Online 0 1 23167 3305 21582 4890 Sum $10,547,825.85 1,566,523.30 $20,584,445.79 5,178,397.51 Mean $455.30 473.99 $953.78 1,058.98

_0CLV

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References
Gupta, Sunil; Hanseens, Dominique; and others. Modeling Customer Lifetime Value. Journal of Service Research, Volume 9 (2), 2 November 2006, pg. 139-155. Hayes, Bob. Lessons in Loyalty. Customer Loyalty. QP March 2011, pg. 24-31. Ogden, David. Mathematical Methodologies for Calculating Customer Lifetime Value. The SAS Institute, 2012.