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.

HBSWK Pub. Date: Mar 4, 2002

by Peter K. Jacobs

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."

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.

Narakesari Narayandas is an associate professor of Business Administration at Harvard Business School.

Books by Narakesari Narayandas

Other HBS Working Knowledge stories featuring Narakesari Narayandas:
Parents’ Guide to Harvard Business School

V. Kasturi Rangan is Eliot I. Snider and Family Professor of Business Administration at Harvard Business School.

http://hbswk.hbs.edu/pubitem.jhtmlid=2816&sid=0&pid=0&t=marketing