04 Mar 2002  Research & Ideas

Don’t Lose Money With Customers

Executives talk a good game about managing customer relationships. But then why do many companies persist in money-losing arrangements? Time to become proactive, says Harvard Business School professor Narakesari Narayandas.

 

Investors diligently manage financial portfolios to maximize returns on their assets; yet corporate managers who invariably proclaim their business customers to be "valuable assets" rarely manage their relationships with them for optimal gain. Indeed, while reluctant to admit it, many companies knowingly persist in money-losing customer relationships. Why such inconsistent behavior?

HBS associate professor Narakesari ("Das") Narayandas has been investigating the various stances that companies, deliberately and otherwise, maintain toward their corporate customers. In a series of articles and HBS Working Papers, he explores the process of how firms in business-to-business markets manage customer relationships.

As a frame of reference, Narayandas explains that modern marketing occurs at three distinct levels. Companies craft their corporate vision and mission statements at the market level, then translate these into strategies at the market segment level. A paper mill's marketing strategy, for instance, might call for selling newsprint to the publishing industry segment and paperboard to the packaging industry.

The third level focuses on the individual customer. "Firms today have access to a wealth of information about customers and sales prospects," says Narayandas. "Now more than ever before, companies are able to leverage technology to work more closely and to collaborate in new ways with customers—from designing and developing new products to providing automatic inventory-replenishment services and improving customer service. It therefore becomes imperative that companies not only manage markets and segments, but also learn how to manage relationships with their individual corporate customers proactively."

It doesn't matter how disciplined firms are at the market and segment levels if the same focus and precision don't exist in customer choice.
— Narakesari Narayandas

Accomplishing this requires finely tuned approaches that target individual and/or small groups of customers, explains Narayandas. His investigations reveal, however, that most companies that claim to practice customer relationship management actually focus on managing individual customer interactions. While they think they are talking strategy, firms are actually mired in the execution of tactics.

What's a company to do?

Narayandas divides the process of managing customer relationships in the business-to-business environment into four distinct phases:

  • defining and building a portfolio of customers the firm wants to serve,
  • crafting and implementing relationship-management strategies,
  • monitoring the status and health of customer relationships,
  • linking the customer management effort to profitability.

The initial phase is important, he says, because the customers a company serves define the very nature of the organization itself and, in turn, the customers and prospects it will be able to serve in the future. "It doesn't matter how disciplined firms are at the market and segment levels if the same focus and precision don't exist in customer choice as well," Narayandas points out.

In the second phase, Narayandas identifies three key aspects of managing customer relationships. First, firms need to plan how they will sell different products and services to each customer over time. Second, they need to be clear about how to sell the same product or service simultaneously to customers that have very different valuations of the firms' offerings. Finally, firms need to link the value they create for their customers with the value they are able to extract for themselves. Jet engine manufacturers, for example, typically sell their wares at little or no cost but generate substantial revenue from lucrative maintenance contracts.

Monitoring relationship health, the third phase of the process, requires tracking the voice of the customer. "Sometimes it makes sense to have a conversation with customers to find out how satisfied they are, and there are other times when the vendor might be better off drawing inferences from observations of actual customer behavior," Narayandas says. "Customer satisfaction is just one part of the big picture when it comes to monitoring customer health."

Linking such feedback to relationship performance completes the customer management process loop. This requires tracking profitability at the customer level—a potentially difficult task, since most existing measurement systems are designed to track profitability only at the market and segment levels. Consequently, many managers are often forced to make important customer decisions based on hunches and imprecise information. Systems that enable firms to compare their investment in managing individual customer relationships with the short- and long-run benefits that each generates will help companies make informed decisions about how to serve their customers more profitably in the future.

Probing the process

Working with several other scholars, Narayandas has focused attention on three aspects of the customer management process. One study, completed in collaboration with HBS professor V. Kasturi Rangan, addresses the strategy design and implementation phase of the process by exploring how buyer-seller relationships function in a business-to-business setting.

Previous research, says Narayandas, generally presumed that buyer-seller relationships were either adversarial or cooperative throughout the partnership's life. "What we discovered," he explains, "is that industrial relationships commonly begin in an adversarial mode, where one party holds a dominant position. However, in those relationships that are successful over time, the parties, despite obvious power disparities, work together to develop a spirit of mutual trust and cooperation that gradually brings a degree of balance to their dealings with each other."

Narayandas and Rangan explore this phenomenon by examining several of these relationships in depth. An electrical parts distributor for General Electric, they observed, initially adhered closely to its informal agreement with the company, but eventually provided additional service that surpassed the obligations of its contract—an effort later recognized and rewarded by GE. In contrast, a supplier of circuit boards to Ford Motor Company was never able to overcome a preoccupation with the contract terms. The supplier's failure to manage effectively this aspect of an otherwise promising relationship with the automaker quickly led to its termination. "The lesson here," says Narayandas, "is that relationships can succeed, even if they are asymmetrical to begin with, provided that companies manage them for mutual long-term gain."

A second study, undertaken with Associate Professor Douglas Bowman of Emory University's Goizueta Business School, investigates the link between a firm's investment in managing its customer relationships and the profitability those relationships generate. Prior research in this area, notes Narayandas, focused on customer satisfaction. The drawback to this approach, however, is that satisfying buyer demands can sometimes cost more than the revenue actually generated.

By studying numerous companies and their customers across multiple industries, the researchers learned that the way firms derive profit through the customer management process is influenced by account-specific factors and the nature of the respective market's competitive environment. Business size, loyalty, and the seller's share of a customer's total purchases are all important determinants of profitability.

In a third study, Narayandas and Goizueta associate professor Sundar Bharadwaj examine why companies persist in maintaining underperforming customer relationships. This research addresses the final phase of the process—comparing the resources invested in managing customer relationships with the results they generate, and applying that information to decide on future courses of action. Here, Narayandas and Bharadwaj unveil several factors that lead sellers to remain in money-losing relationships with their customers, including, among others:

  • the nature and level of investments made in the relationship (higher levels of relationship-specific investments and lower efficacy of investments, for instance, can be barriers to terminating relationships),
  • the nature of performance change (a gradual decay in performance can increase the likelihood that firms will persevere in underperforming relationships),
  • organizational factors (for example, an emphasis on customer orientation can hurt when managers are reluctant to terminate an unprofitable relationship for fear of being ostracized for their actions),
  • relationship-specific factors (competitive grandstanding, for instance, can lead to a decision by vendors to persist in unprofitable relationships).

Narayandas and his colleagues find that much remains to be explored in this area of study. Still, their work so far makes clear the many opportunities that await companies willing to devote resources to this increasingly important aspect of marketing—and the pitfalls awaiting those that do not. "Proactively managing customer relationships," Narayandas concludes, "will become an increasingly important strategic weapon in the arsenals of business-to-business marketers."

Excerpted with permission from "Customer Portfolios: Managing a Vital Asset," Leading Research, Vol. V Number 1, 2002.

Peter K. Jacobs is a freelance business writer.