A Note on Willingness to Spend and Customer Lifetime Value for Firms with Limited Capacity Phillip E. Pfeifer ⁎ & Anton Ovchinnikov Darden Graduate School of Business, University of Virginia, 100 Darden Boulevard, Charlottesville, VA 22903, USA Available online 11 April 2011 Abstract The paper draws a distinction between customer lifetime value (CLV) and willingness to spend (WTS). By WTS we mean the maximum amount the firm should be willing to spend to acquire (retain) the customer relationship. In order to avoid the double counting of cash flows when summing the CLVs of customers, we suggest including only direct cash flows in the formulation of CLV. This convention means that CLV will equal WTS if (and, for the most part, only if) the firm's relationships with customers are independent. By independent we mean that the acquisition (retention) of Jane Doe has no effect on the cash flows of any other current or future customers. In contrast to well-understood demand- side dependencies among customer relationships (such as referrals), this paper highlights a particular kind of supply-side dependency—that created when the firm is limited in the number of customers it can serve. Using an extended version of the model of Blattberg and Deighton (“Manage Marketing by the Customer Equity Test,” Harvard Business Review, July–August 1996, 136–144) of customer equity, we demonstrate that, for a firm at capacity (in this model), CLV is no longer relevant to marketing spending decisions and the firm can prefer a lower-CLV customer. © 2011 Direct Marketing Educational Foundation, Inc. Published by Elsevier Inc. All rights reserved. Keywords: Customer lifetime value; Marketing spending; Customer relationship management Introduction To the best of our knowledge, it was Bursk (1966) who introduced the concept now commonly referred to as customer lifetime value (CLV) with his suggestion that firms use the “investment value” of a customer to guide marketing spending decisions. Attention directed toward CLV helps shift focus from transactions (finding more buyers for the firm's products) to relationships (finding more ways to serve the firm's customers). Using CLV to guide marketing decisions also encourages firms to recognize differences among customers and begin to create value though differen- tial treatment. For these and other reasons, the concept of CLV receives much attention from marketing practitioners and academics (e.g., Rust, Zeithaml, and Lemon 2000; Blattberg, Getz, and Thomas 2001; Gupta et al. 2006; Blattberg, Malthouse, and Neslin 2009). For our purposes, CLV is defined as the present value of the future cash flows attributed to the customer relationship (Pfeifer, Haskins, and Conroy 2005). By design, this definition is flexible; it can be applied at any point in the firm's relationship with a customer. Thus, it makes sense to talk about the (remaining) lifetime value (or CLV) of an existing customer (and attempts by the firm to maximize that value) as well as the value of a newly acquired customer. Although the definition of CLV means it applies to both new and existing customers, to keep things simple and avoid confusion, we adopt the default assumption that (unless otherwise noted) CLV refers to the present value of customer cash flows if and when acquired. Notice also that the definition is silent with respect to what cash flows should be attributed to the customer relationship. There appears to be agreement, however, that the sum of the CLVs of the firm's current and future customers (net of acquisition costs) is a measure of the value of the firm (see, for example, Bayon, Gutsche, and Bauer 2002; Berger et al. 2006; Gupta et al. 2006; Rust, Zeithaml, and Lemon 2000). In order for CLVs to sum to something meaningful, there ⁎ Corresponding author. E-mail address: pfeiferp@virginia.edu (P.E. Pfeifer). 1094-9968/$ - see front matter © 2011 Direct Marketing Educational Foundation, Inc. Published by Elsevier Inc. All rights reserved. doi:10.1016/j.intmar.2011.02.003 Available online at www.sciencedirect.com Journal of Interactive Marketing 25 (2011) 178 – 189 www.elsevier.com/locate/intmar