25 Mar 2011Working Paper Summaries

How Do Incumbents Fare in the Face of Increased Service Competition?

by Ryan W. Buell, Dennis Campbell and Frances X. Frei

Companies that compete by offering a high level of service are particularly vulnerable to lose customers—even longtime customers—when competitive entrants offer increased service levels, according to new research in the retail banking industry by Ryan W. Buell, Dennis Campbell, and Frances X. Frei, all of Harvard Business School. The good news for providers of high-touch service is that if they can sustain the service advantage over time, they could be rewarded with higher value customers. Key concepts include:

Incumbents offering high quality service attract and retain customers who are disproportionately service sensitive and systematically vulnerable to competitors offering superior service.
It is the high quality incumbent's most valuable customers—those with the longest tenure, most products, and highest balances—who are the most vulnerable to superior service alternatives.
Conversely, when the incumbent fails to maintain a high service position within the market, its customers are vulnerable to competitors offering inferior service but lower prices.
Firms that make the strategic decision not to compete on service may not need to be concerned about the entry or expansion of competitors offering superior service.
A long-run implication is that incumbents that can sustain a high level of service relative to local competitors will be able to attract and retain higher value customers over time.

Author Abstract

We explore the conditions under which service competition leads to customer defection from an incumbent and which customers are most vulnerable to its effects. We find that customers defect at a higher rate from the incumbent following increased service competition only when the incumbent offers high quality service relative to existing competitors in a local market. We provide evidence that this result is due to a sorting effect whereby the incumbent attracts service (price) sensitive customers in markets where it has supplied relatively high (low) levels of service quality in the past. Furthermore, we show that it is the high quality incumbent's most valuable customers, those with the longest tenure, most products, and highest balances, who are the most vulnerable to superior service alternatives. Along the way, we also show that firms trade off price and service quality and that when the incumbent offers relatively low service quality in a local market, it is susceptible to the entry or expansion of inferior service (price) competitors. Our results appear to have long-run implications whereby sustaining a high level of service relative to local competitors leads the incumbent to attract and retain higher value customers over time.