Strategic Value of High-Cost Customers: Online Appendix
Management Science, Forthcoming
16 Pages Posted: 3 Sep 2013
Date Written: May 2, 2013
This is the online appendix to the paper titled "Strategic Value of High-Cost Customers" that is forthcoming in Management Science. The abstract for the paper is given below. This online appendix provides the proofs for extensions when customers are forward-looking, when there are three customer cost-types, when firms can discriminate amongst their ex-customers, when customers exhibit inertial loyalty or brand loyalty, when customers also differ in their price-sensitivity and when some customers are too costly to serve.
Many firms today manage their existing customers differentially based on profit potential, providing fewer incentives to less profitable customers and firing unprofitable customers. While 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 amongst its customers while 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 towards 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.
Keywords: Competitive Strategy, Customer Lifetime Value, Customer Profitability, Customer Relationship Management, Dynamic Competition, Price Discrimination, Game Theory
JEL Classification: M30, C72, D82
Suggested Citation: Suggested Citation