Malvern, Pa. — Businesses thinking of divesting unprofitable customers shouldn't act hastily, according to a new study by researchers Vikas Mittal, professor of marketing and management at Rice University's Jones Graduate School of Management; Matthew Sarkees, assistant professor of marketing at Penn State Great Valley School of Graduate Professional Studies; and Feisal Murshed, assistant professor of marketing and e-business at Towson University.
In the study, titled "The Right Way to Manage Unprofitable Customers," published in the April issue of Harvard Business Review, the three researchers say although customer divestment is an important strategic option for managers, they need to look past simple cost-profit analysis when they consider shedding customers. What appears on paper to be a sound strategic move can turn into a nightmare.
"We looked across industries from both the manager and the customer perspectives. We noted customer divestment in healthcare, banking, professional services, and the retail industries, among many others. Managers need to better understand the concept of customer divestment, and customers--both business and consumer--need to know that the potential for divestment exists," said Sarkees.
The study found that reasons for divestment typically fall into four categories: falling profitability of certain customers; the lower productivity of employees managing unprofitable customers, who often register a disproportionate number of complaints; changes in a company’s capacity to serve certain customer segments; or changes in a company’s business strategy.
The researchers found that many firms lack a formal customer divestment program, which is important to obtain a better understanding of the current state of these relationships. They provide a structured continuum of stages that firms can move through before divesting a customer, including:
--Reassessing the present relationship and the reason why a customer may be spending less than it did before. Are there other products that can be offered to this client?
--Educating customers so they understand what the business offers, as well as products and services that fulfill their needs the best. An informed customer is more likely to be a faithful customer.
--Renegotiating the value proposition. Make sure that the customer is paying a fair price for the products and services provided, one that will allow for profit.
--Migrating customers. If renegotiation proves unrealistic, companies can often move unprofitable customers to a service level where the value exchange makes more sense.
"While firing your customers can make sense in certain situations, there are many more circumstances in which the risks of such a strategy outweigh the rewards," the researchers wrote. "It’s not just profits that are at stake; multiple constituencies are affected when businesses decide to divest."
For example, a business with high fixed costs that divests customers risks placing more of a cost burden on its remaining clients. An example mentioned in the study is that of a physician who let go of two unprofitable patient segments, and then found it difficult to fill up her appointment schedule. Since the physician was reluctant to let any of her long-term employees go, she was left with too many employees and too few patients, and her cost to do business rose precipitously. The doctor wound up buying another medical practice just to get back to the break-even point.
And when companies shed customers, it often leads to a downsized workforce, which can leave the prevailing workforce in disarray. For example, in 2005, insurance giant Marsh & McLennan jettisoned thousands of clients worldwide after a long-overdue profit audit determined that the company was losing money on about 25 percent of its customer base. The company divested itself of its unprofitable customers, as well as the employees who supported those customers. The brokers that remained were frustrated and angry with the way the former clients and colleagues had been treated, and many defected to competitors.
"The lesson here is that a company's treatment of its customers sends a powerful message--whether intended or not--about how well management treats its employees," the researchers wrote, adding that customers who feel like they've been divested simply because they did not generate enough profit are likely to spread more negative messages about the business that let them go.
In the end, divesting customers is more about getting back on track as a business refocuses resources in a manner that treats everyone fairly.
"The relationship between a company and its customers is complex and ever-evolving, and therefore requires active management. Specifically, customers are not commodities that can be acquired or disposed of at will," the researchers wrote. "Customer divestment is a viable strategic option, but it should be exercised sparingly, heedfully and cautiously. The customer base, even if unprofitable, is not a resource any firm can afford to squander."