Design to learn: customizing services when the future matters

Abstract

Internet-based customization tools can be used to design service encounters that maximize customers’ utility in the present or explore their tastes to provide more value in the future, where these two goals conflict with each other. Maximizing expected customer satisfaction in the present leads to slow rates of learning that may limit the ability to provide quality in the future. An emphasis on learning can lead to unsatisfied customers that will not only forego purchasing in the current period, but, more seriously, never return if they lose trust in the service provider’s ability to meet their needs. This paper describes service design policies that balance the objectives of learning and selling by characterizing customer lifetime value as a function of knowledge. The analysis of the customization problem as a dynamic program yields three results. The first result is the characterization of customization policies that quantify the value of knowledge so as to adequately balance the expected revenue of present and future interactions. The second result is an analysis of the impact of operational decisions on loyalty, learning, and profitability over time. Finally, the quantification of the value of knowing the customer provides a connection between customer acquisition and retention policies, thus enhancing the current understanding of the mechanisms connecting service customization, value creation, and customer lifetime value.