Why Firing Your Worst Customers Isn’t Such a Great Idea

customer centric Why Firing Your Worst Customers Isnt Such a Great Idea Here are several excerpts from an article published by Knowledge@Wharton (free registration required), the online journal of the Wharton school of Business at the University of Pennsylvania, Why Firing Your Worst Customers Isn’t Such a Great Idea:

Fire your bad customers.

That piece of advice has become widely accepted in recent years as companies have sought to manage their relationships with customers in more sophisticated ways. The rationale for this idea is clear-cut: Low-value customers — such as the ones who hardly spend any money on your services or products yet tie up your company’s phone lines with questions and complaints — end up costing more money than they provide. So why not jettison them and focus your customer-relationship efforts on more profitable individuals? Or, as an alternative, why not at least try to increase the worth of the low-value customers to your firm? If a firm has only valuable customers, the thinking goes, its profitability and shareholder value should increase.

It all sounds quite rational, and many corporations have jumped on the bandwagon. But a new study by two Wharton marketing professors, Jagmohan Raju and Z. John Zhang, and Wharton doctoral student Upender Subramanian, cautions that firing low-value customers may actually decrease firm profits and that trying to increase the value of these customers may be counterproductive.

In the study, “Customer Value-based Management: Competitive Implications,” Zhang, Raju and Subramanian break ground by analyzing CVM in the context of a competitive environment. The researchers acknowledge that firing bad customers may make some sense in industries where there is little or no competition. If a firm treats all customers equally, the argument goes, not only does the company waste resources on attracting and retaining unprofitable customers, it also under-serves profitable customers, who may become unhappy and leave.

Competitors can be ‘poachers’

For the overwhelming majority of companies operating in a competitive environment, firing low-value customers can be counterproductive, the researchers conclude. The key reason: Companies that rid themselves of low-value customers — or take steps to turn low-value customers into high-value ones — leave themselves open to successful poaching by competitors. If the competition knows that you have fired many or all of your low-value customers, they are likely to intensify their efforts to take your remaining customers away from you because they now know that all, or most, of those remaining customers are of the high-value variety.

“What our analysis tells us is companies make money, in part, by confusing their competitors about their customers,” Raju says. “If you make your customer base transparent by firing your low-value customers, competitors will hit you hard because you will be left with customers of one type.’

Instead of firing unprofitable customers, some companies have tried to turn them into high-value customers by giving them inducements to change their behavior, such as teaching them to spend more or to use low-cost support channels. But the Wharton researchers found that this idea is also wrongheaded.

“If you make low-value customers more valuable, this can also be counter-productive because it also encourages your competitors to poach more intensely,” Raju says.

So what is the proper way to manage relationships with low- and high-value customers?

“Our research finds that a better approach is to improve the quality of your high-end customers at the same time that you keep your low-end customers, but you should find other, cheaper ways to manage the low-value customers, such as encouraging them to use automated phone-response systems or the Internet or offering minimal discounts or other benefits,” Raju says. “You have to keep your competition confused about who your good and bad customers are.”

Summary

“What we’d like readers to take away from our paper is that just ‘cleaning up’ your customer base is not good enough,” Raju says. “You should focus on good customers and try to improve their quality and not just try to get rid of the bad ones. Firms should find cheaper ways to keep low-value customers because they are confusing your competition to your advantage and there’s a chance someday that they will become good customers.”