The Strategic Value of High-Cost Customers

Abstract

Many firms today manage their existing customers differentially based on profit potential, providing fewer incentives to less profitable customers and firing unprofitable customers. Although researchers and industry experts advocate this practice, results have been mixed. We examine this practice explicitly accounting for competition and find that some conventional prescriptions may not always hold. We analyze a setting where customers differ in their cost to serve. We find that when a firm can discriminate among its customers but the rival cannot, customer base composition influences the rival's poaching behavior. Consequently, even though a low-cost customer is more profitable when viewed in isolation, a high-cost customer may be strategically more valuable by discouraging poaching. Therefore, contrary to conventional advice, it can be profitable for a firm to retain unprofitable customers. Moreover, some customers may become more valuable to retain and receive better incentives when they are less profitable. We further show that, in competitive settings, traditional customer lifetime value metrics may lead to poor retention decisions because they do not account for the competitive externality that actions toward some customers impose on the cash flows from other customers. Our results suggest that firms may need to evolve from a segmentation mindset, which views each customer in isolation, to a customer portfolio mindset, which recognizes that the value of different customers is interlinked. This paper was accepted by J. Miguel Villas-Boas, marketing.

Retention Futility: Targeting High-Risk Customers Might be Ineffective

“…I acknowledge that the proposed method does not explicitly incorporate competitors' actions. As highlighted by Subramanian, Raju, and Zhang (2013), the firm's most valuable customers might easily be the ones who competitors aim to poach, making those customers most responsive to retention efforts (provided that the offered incentive compensates the competitive alternatives), whereas those with lower value to the firm might not be as attractive to competitors and, thus, might be the most insensitive to retention actions. However, as documented by Du, Kamakura, and Mela (2007), customers who have low levels of expenditure with the focal firm might be spending most of their share of wallet with competing firms, potentially making these customers more sensitive to incentives from the focal firm.…”

Behavior‐ and characteristic‐based price discrimination

“…Shin, Sudhir, and Yoon () consider a monopolist firm which, after the initial purchase of customers, is able to recognize which of them are more costly to serve, and it might deliberately decide not to serve them in the subsequent periods. Subramanian, Raju, and John Zhang () extend Shin et al. () to a duopoly context, and find that high‐cost customers may be strategically valuable, as long as they discourage poaching by the rivals.…”

Brave New World? On AI and the Management of Customer Relationships

“…The danger, however, is the selective discrimination we have discussed abovecustomers who are considered unprofitable or barely profitable will be abandoned by most firms (Haenlein & Kaplan, 2009). This, in turn, may lead to the rise of new competitors specializing in this type of client base (Rosenblum et al, 2003), as well as more intense competition among firms who abandoned them (Subramanian, Raju, & Zhang, 2014). Also, receiving consistently lower service may push such lower-value customers to falsify their online data and generate fake online profiles.…”