An Integrated Framework for Optimizing Customer Retention Budget using Clustering, Classification, and Mathematical Optimization

Abstract

The study presents a comprehensive framework for optimizing customer retention budget by integrating clustering, classification, and mathematical optimization techniques. The study begins with the IBM Telco dataset, which is prepared through data cleansing, encoding, and scaling. In the preliminary phase, customer segmentation is performed using K-Means clustering, with k = 3 and k = 4 identified as optimal based on the elbow method and Silhouette score. The configurations produced three (Premium, Standard, Low) and four (Premium, Standard Plus, Standard, Low) customer segments based on purchase preferences, which served as input features for churn prediction. In the second phase, the dataset was divided into training and test sets in an 80:20 ratio, followed by data balancing using the Synthetic Minority Over-sampling Technique (SMOTE) and Edited Nearest Neighbors (ENN). Multiple classification algorithms were evaluated, including Naive Bayes (NB), Random Forest (RF), Categorical Boosting (CatBoost), Light Gradient Boosting Machine (LightGBM), Extreme Gradient Boosting (XGBoost), Gradient Boosting (GB), Support Vector Machine (SVM), Logistic Regression (LR), K-Nearest Neighbors (KNN), and Multi-Layer Perceptron (MLP) using F1-score as the performance metric. CatBoost and LightGBM, with k values of 3 and 4, respectively, were the highest-performing classification models, with only minimal differences in performance. Ultimately, customer segmentation established customer prioritization, whereas churn prediction assessed customer churn likelihood. Four distinct configurations were assessed utilizing mixed-integer linear programming (MILP) to optimise retention budget allocation within uniform budget constraints, discount amounts, and churn thresholds. In both the k=3 and k=4 scenarios, CatBoost surpassed LightGBM, with CatBoost at K=3 effectively discounting 66% of at-risk consumers across all three segments, hence improving the intervention's efficacy and budget allocation, making it the ideal choice for maximizing customer retention. The results demonstrate the importance of segmentation in enhancing retention budgeting and budget optimization, particularly concerning parameter sensitivity.

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