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Keeping Bad Apples

Firing your worst customers could be bad for business.
Eila Rana, CFO Europe Magazine
February 4, 2008

"The customer is king" is probably the most common management mantra. Coming in second, however, is "Fire bad customers." A host of management books — "Angel Customers and Demon Customers: Discover Which is Which and Turbo-Charge your Stock" by Geoffrey Colvin and Larry Selden is a good example — declare that companies do themselves harm by keeping customers whose demands for time and attention outstrip the amount they spend.

But new research by Jagmohan Raju and Z. John Zhang, two Wharton Business School professors, claims that bad customers can be good for business. Why? When a company has a mix of profitable and unprofitable customers, it makes rivals less inclined to poach its clients. On the other hand, suggests Zhang, "if I, as the competition, know you only have good customers, then I will increase my intensity to poach them." Fending off this competition can damage profits.

Don't shareholders mind "angel" customers subsidising "demons"? Zhang says it's a price worth paying to protect the top 20% of customers who, according to a rule of thumb, generate 80% of profits. In challenging the conventional wisdom, "you get people who really hate what we do," he says. "Consultants, especially, say it just doesn't make sense."

Robert Bryant, head of Deloitte's customer management practice, is one. He says he's never heard a client justify unprofitable customer relationships "so that we can confuse our competitors into not knowing who to poach." It's more likely, he says, that companies will try to service problematic customers through low-cost routes such as the internet.

The reality in boardrooms is more complicated. Few CFOs want to be seen ditching or discriminating against customers, unprofitable or not, according to Arnd Zinnhardt, CFO of IT company Software AG. This is true at the Darmstadt-based firm, which aims to increase annual revenue from €632m to €1 billion by 2011. "Even our smaller contracts are typically with customers operating in multinational organisations, so there are always opportunities to expand your service to other geographies, or offer other products," says Zinnhardt. "Upsetting a customer by treating him differently would affect that opportunity."




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