Competitive Customer Relationship Management: Acquisition versus Retention

Competitive Customer Relationship Management: Acquisition versus Retention Niladri B. Syam Assistant Professor of Marketing James D. Hess C.T. Bauer Professor of Marketing Science Under review for publication in American Economic Review

Churn, Churn, Churn The Byrds with Music by Pete SeegerTo every customer (churn, churn, churn)There is a season (churn, churn, churn)And a time for every purchase, in our theory.A time to acquire, a time to retain,A time to segment, a time to reap,A time to prospect, a time to relate,A time to compete, I swear its not too late. To every customer (churn, churn, churn)There is a season (churn, churn, churn)And a time for every purchase, in our theory.

Extant literature on CRM • A very rich conceptual and empirical literature on Customer Relationship Management including: Morgan and Hunt (1994); Reinartz and Kumar (2000 and 2003); Verhoef (2003); Sharp and Sharp (1997) etc. • A very large body of trade press articles: mainly operational/tactical • Rick Staelin’s 2005 overview paper in JM “A Customer Relationship Management Roadmap: What is Known, Potential Pitfalls, and Where to Go” said: “We find it surprising that the CRM literature and the articles in this special section are largely silent on the issue of competitive reaction.”

What is CRM? Some prospects have larger potential lifetime sales than other prospects. For those better prospects the firm does special things to transform them into long-lived customers (that is, build a relationship). Customers often have other suppliers to which they could turn. Element 1: Heterogeneity Element 2: Multiperiod buying Element 3: Differential treatment Element 4: Addressability Element 5: Churn

One other element How many customers to have in the club and how to reward them is distinct from the decision of when to reward them. Despite a firm’s best efforts, some consumers will still ‘churn’ in the future and makes the timing of rewards another important strategic decision.

Research question 1 The motivation: If ‘special services’ are to be provided, should it be now or in the future? The effect: With early provision you can attract more customers (Acquisition), with later provision you are better able to keep them (Retention). Trade press is ambiguous. Alternate viewpoint: Up-front investments create ‘customer assets’. Promises of future investments create ‘customer liabilities’ (Shugan, 2005). The Question: Does a firm’s choice of acquisition or retention depend on it’s rival’s choice? What is equilibrium outcome?

Research question 2 The motivation: Consumers are fickle The effect: ‘Customer churn’ can affect profitability of CRM (A McKinsey study finds 32% churn in wireless mkt in 2000) Alternate viewpoint: Low intrinsic ‘retainability’ of customers makes retention strategies ineffective (Blattberg and Deighton 1996) The Question: How does churn affect equilibrium strategies? Are the effects on retention and acquisition different?

Research question 3 The motivation: What’s in it for the consumers? The effect: Viability of relationship marketing is questionable since it may not be in consumers’ interest to form exclusive relationships with firms (Day 2000; Fournier, Dobscha, and Mick 1998) Alternate viewpoint: When firms create customer liabilities (retention), “…rather than showing trust in customers, the firm asks customers to trust it.” (Shugan 2005) The Question: If a firm adopts retention, are its interests misaligned with those of its customers?

Now… for our choices on Element 1: Heterogeneity Element 2: Multiperiod buying Element 3: Differential treatment Element 4: Addressability Element 5: Churn

Club C Basic C Basic D Club D Seller Seller C D Picture of CRM competition • . Now Future Basic customers abandon the category Club C Club D Customer Churn

Model of CRM competition: The basic product • Firms C and D psychologically locate at either end of a unit interval of attributes • Customers are heterogeneous in affiliation to the firms and are uniformly distributed on the unit interval. • The consumer’s surplus from C’s and D’s basic product is U-x-PCb, and U-(1-x)-PDb

The augmented product determines the Buyer Club • When a firm implements CRM, it augments its basic product by service S • A consumer’s valuation of the service depends on their affinity to the firm: for C it is S(1-x). • A consumer that gets augmented product from C has surplus U-x+S(1-x)-PCa. • ‘Now’ and ‘future’ are captured by having two time periods t=1, 2

Rewarding Buyer Club members • When to reward: this determines Acquisition or Retention strategy • How to reward? Options include 1. Personalizing the product (our choice) 2. Add to utility: E 3. E valued according to location: E(1-x)

Acquisition strategy • Personalization for club members occurs in the first period. • If firm C adopts acquisition, the first and second period surpluses are U+S-PC1, and U-x+S(1-x)-PC2

Retention strategy • Personalization for club members occurs in the second period. • If firm C adopts retention the first and second period surpluses are U-x+S(1-x)-PC1 and U+S-PC2

Analysis of competition • Firms C and D can each pursue acquisition or retention • This creates four distinct subgames: <r, r>, <a, a>, <a, r>, and <r, a>. • Game structure: Stage 1: Firms simultaneously choose CRM strategies Stage 2: All six prices are chosen conditional on first stage choice

Join Club C Buy Basic C 0 X X C12 b The <r, r> subgame • Consumer surplus for two-period club membership: CSC12={U-x+S(1-x)– PC1}+{U+S-PC2} • Consumer surplus for basic product: CSCb=U-x–PCb • Join club rather than buy basic product if • CSC12> CSCb  x< ≡XC12 .

Consumer Surpluses CSC12 CSDb CSCb Seller Seller x, Ideal Points D C 1 0 XC12 Xb Join Club Buy Basic C C The <r, r> subgame • The market segmentation CSD12 XD12 Buy Basic Join Club D D

The <a, a> subgame • Acquisition-oriented firm is vulnerable to opportunism • People will sign up for club if CSC12> CSCb . This gives XC12 as in retention case. • Second-period marginal consumer, CS2=U-x+S(1-x) –PC2=0, is at XC2≡ • Firm will set prices to eliminate opportunism C XC2 Opportunistic customers XC12

How to deal with opportunism? • Firm C should increase PC1 till XC12 equals XC2 • Note that increasing PC1 has no effect on XC2 • Is this optimal for firm C? -Yes • Can this constitute a Nash Equilibrium in prices? -Yes

How does ‘churn rate’ enter? • Churn only occurs in the second period • Consumers leave a firm’s club to join the rival’s club • C’s profit function with churn rate c is Out Churn In Churn

Nash Equilibrium Prices • Prices in <r, r> subgame: • Prices in <a, a> subgame:

A comparison of churn volume • PROPOSITION 1: • In equilibrium, a firm will have a smaller club size with a retention strategy than with an acquisition strategy, regardless of the strategy adopted by its rival. • In equilibrium, a firm will have fewer churning customers with a retention strategy than with an acquisition strategy, regardless of the strategy adopted by its rival.

A comparison of prices • PROPOSITION 2: • A firm’s first-period price is higher with acquisition than with retention, and its second-period price is higher with retention than with acquisition, regardless of its rival’s strategy. • A firm’s ‘club price’ for the augmented products over two periods is higher with a retention strategy than with an acquisition strategy, regardless of its rival’s strategy.

Acquisition-Retention Profits as a Function of Churn Rate Figure 3

The Nash equilibrium Theorem 1: The Nash equilibria of CRM competition with customer churn are asymmetric: r, a or a, r. D C

Intuition for result • The basic drivers for the asymmetric equilibrium are 1. Churn 2. Different strategic effects of acquisition and retention • Recall: In equilibrium we find that: Club size of acquisition firm > Club size of retention firm

Intuition (contd.) • The retention strategy gains more customers than it loses due to churn • This windfall implies that the best response to acquisition is retention • This benefit is enormous enough that….

Some interesting profit comparisons • Proposition 3: In equilibrium, the retention strategy is more profitable than the acquisition strategy. However… • Proposition 4: Off-equilibrium

Consider a monopoly benchmark Theorem 2 : In the presence of churn, the optimal strategy for a monopolist is acquisition. Rationale: Since retention strategy has higher second period price, churn hurts it more

Two take-aways 1. A monopolist should pursue an acquisition strategy, but when faced with competition it should switch to a retention strategy. 2. Competition is the causal link to a retention strategy.

A consumer surplus result • Proposition 6: Suppose a firm adopts CRM with a retention strategy. The customers’ surpluses are higher when churn rate is lower. That is, it pays to be loyal.

Standardized Rewards • THEOREM 3: There exists a critical churn rate threshold such that: • If churn rate is low, one firm adopts retention CRM and the other adopts acquisition CRM. • If churn rate is high, both firms adopt retention CRM.

Variations on the theme • What if consumers are myopic? • What if churn is not exogenous? • Personalized pricing?

Summary • Regardless of costs, retention is the best loyalty program strategy when there are rival CRM firms. It’s the competition, stupid. Make them focus on acquisition! • It is in the self-interest of the customer population to reduce churn rate.

Competitive Customer Relationship Management: Acquisition versus Retention