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Page 1: Manage Unprofitable Customers

94 Harvard Business Review | April 2008 | hbr.org

1084 Mittal.indd 941084 Mittal.indd 94 3/4/08 10:15:49 PM3/4/08 10:15:49 PM

Page 2: Manage Unprofitable Customers

Don’t just dump customers that cost you money.

Use this framework to decide how best to fi x or end

the relationships.

The Right Way to Manage

hbr.org | April 2008 | Harvard Business Review 95

Unprofi table Customers

Bria

n S

tauf

fer

by Vikas Mittal, Matthew Sarkees, and Feisal Murshed

SPRINT NEXTEL sent out letters to about 1,000 people on June 29,

2007, to inform them that they had been summarily dismissed –

but the recipients were Sprint customers, not employees. For about

a year, the wireless-service provider had been tracking the number

and frequency of support calls made by a group of high-maintenance

end users. As a Sprint spokeswoman told Reuters in July, “In some

cases, they were calling customer care hundreds of times a month…

on the same issues, even after we felt those issues had been resolved.”

Ultimately, the company determined it could not meet the billing

and service needs of this tiny subset of subscribers and, therefore,

waived their termination fees and cut off their service.

Similarly, TXU, a large power provider in Texas, in 2005 imple-

mented a tough-love marketing strategy in response to the competitive

pressures of a deregulated energy market. It pulled the plug quickly on

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Page 3: Manage Unprofitable Customers

The Right Way to Manage Unprofi table Customers

96 Harvard Business Review | April 2008 | hbr.org

late-paying customers then charged them expensive recon-

nect fees, and it offered perks to those who paid on time. As

a result, it reduced its “bad debt” from nonpaying customers

and enjoyed productivity increases among employees who

had previously spent a lot of time fi elding calls from scoffl aws.

As one senior TXU fi nancial executive told the Wall Street

Journal, “A customer who calls you every day is less profi table

than one who pays on time and never calls you.”

Customer divestment, whereby a company stops provid-

ing a product or service to an existing customer, was once

considered an anomaly. However, it is fast becoming a vi-

able strategic option for many

organizations. Certainly, the

skyrocketing costs of acquir-

ing new customers and the

complexities of cross-selling to

different market segments con-

tinue to make customer reten-

tion imperative. But some fi rms

are taking advantage of new

segmentation approaches and

technologies that have made

it easier to focus on retaining the right

customers – those who will bring in the

most revenue over time – and, by extension,

to show problem customers the door.

To better understand recent trends in

customer divestment, we took a closer look

at some companies that have rid them-

selves of customers, as well as some of the

customers they let go. We pored over news

reports, press releases, and consumer blogs

and magazines to explore the evolving

customer-company dynamic. In 2005 and 2006, we inter-

viewed 38 executives from 32 companies in a variety of

industries, including IT, manufacturing, health care, fi nance,

and professional services. We also surveyed a random sam-

ple of 236 customers. Of the executives, 90% said they had

given serious thought to divesting customers, and 85% said

they had already undertaken divestment. Of the customers,

23% indicated they had been let go by a company in the

past year.

Our research identifi ed four common reasons why busi-

nesses terminate relationships with end users: the declin-

ing profi tability of specifi c customers, the lower productiv-

ity of employees as they deal with unprofi table customers,

changes in the capacity to serve large volumes of customers,

and shifts in a company’s business strategy. While most of

the managers we interviewed had thought about divesting

customers for one of these reasons, none wanted to acknowl-

edge that publicly. Setting aside the immediate effects of

such a strategy on profi ts and operations, the managers we

spoke with worried about longer-term ramifi cations such as

retaliation by clients or earning a reputation as a “diffi cult”

service provider or an industry rebel. Indeed, the collateral

damage of divestment can be high: You may do your com-

petitors an unintended favor by sending new business their

way. You can damage relationships with the high-value cus-

tomers you retain, who may come to perceive your company

as being service-unfriendly. You

may even violate ethical or legal

obligations to customers.

Before making any moves to

divest, businesses would do well

to walk themselves and their

B2B or B2C customers through

a five-part framework we’ve

developed from our research.

It will help executives consider

the strategic impact of customer

divestment beyond just profi tability. The

model offers a system for objectively assess-

ing the present and potential value of each

customer or cohort – in short, for putting

each customer relationship in context and

deciding on the best course of action. (See

the exhibit “The Customer Divestment Con-

tinuum.”) After you have done the hard work

of reassessing your present relationships with

customers, educating unprofi table customers,

renegotiating the value proposition, or migrat-

ing customers to other partners or providers, you will be

able to more clearly evaluate the importance of such cus-

tomers to the company’s long-term success. Then – and only

then – should you begin terminating relationships.

In certain situations, customer divestment (done right)

can be an effective strategy, although it should clearly be an

option of last resort. Before we examine each element of the

framework in detail, let’s consider the potential benefi ts and

risks of customer divestment.

Why Divest?As we’ve noted, the executives we interviewed offered four

critical reasons why they might consider divesting them-

selves of certain clients, despite the risk of degrading the

overall customer base.

Vikas Mittal ([email protected]) is the J. Hugh Liedtke Professor of Management and Marketing at Rice University’s Jones Graduate School

of Management in Houston. Matthew Sarkees ([email protected]) is an assistant professor of marketing at Penn State University’s Great

Valley School of Graduate Professional Studies in Malvern, Pennsylvania. Feisal Murshed ([email protected]) is an assistant professor

of marketing and e-business at Towson University’s College of Business and Economics in Towson, Maryland.

Some companies view customer divestment as a natural consequence of their evolving strategies.

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Page 4: Manage Unprofitable Customers

hbr.org | April 2008 | Harvard Business Review 97

The fi rst reason to divest is, of course, profi tability. The

popular press is fi lled with stories about B2B and B2C com-

panies that have divested themselves of customers that no

longer provide suffi cient returns on investment. This is a

fairly common situation in the fi nance and insurance in-

dustries, where profi ts depend so much on clients’ risk fac-

tors. In 2005, Allstate and Nationwide divested themselves,

respectively, of 95,000 and 35,000 home owner’s insurance

customers in Florida for fear of massive losses in the future.

That’s because in 2004 and 2005, areas of the state were

signifi cantly affected by seven major hurricanes. Citing high-

risk factors, the insurance industry subsequently reviewed

and terminated hundreds of thousands of home owner poli-

cies across the United States.

Companies in the retail and service sectors have also

divested themselves of customers in order to stem losses. In

a widely publicized example, Boston-based Filene’s Base-

ment in 2003 banned two longtime customers from its

stores nationwide because of their excessive returns and

complaints, which were eating up sales associates’ valuable

time and other resources. In the same vein, retailers like

Sears and Best Buy charge restocking fees on selected items

to discourage customers from returning products that the

store must then mark down because they are, say, out of sea-

son or missing their original packaging. Car rental agencies

understandably reject out of hand customers who have dam-

aged their vehicles in the past. One agency manager told

us that this practice is “an absolutely necessary function” of

his business. “If someone is going to take advantage of our

[high-cost assets],” he said, “we need to protect ourselves.”

Some organizations are systematic about separating the

profi table customers from the unprofi table ones. They use an-

alytical tools and approaches to compute customer lifetime-

value scores and other relevant metrics. For instance, FedEx

in the late 1990s crunched the numbers on its 30 largest

clients – a group that generated about 10% of the shipping

fi rm’s total revenues and volume. According to a 1999 Wall

Street Journal article, the company “found that certain clients,

including some who required lots of residential deliveries,

weren’t bringing in as much revenue as they had promised

when they fi rst negotiated discounted rates with FedEx.” So

the company raised these customers’ rates. Several clients

who balked at the hike were, over time, asked to take their

business elsewhere. A similar situation was described in a

2003 Wall Street Journal article about the University of Texas

Medical Branch in Galveston, which had identifi ed in its

Has the company misunderstood or mishandled

customers, regardless of their

profi tability?

Are the customers inclined to understand

the company’s position?

Can the customers

and the company fi nd new ways

to reap value from each other?

Might the customers be profi table for subsidiaries

or other providers?

Is the value incompatibility between the

customers and the company truly

beyond repair?

CO

NT

INU

UM

CONTEXTS

The Customer Divestment Continuum

Before deciding to sever ties with problem customers, you should ask yourself key questions about the contexts in which those clients are operating. Understanding those contexts can help you determine how – and even whether – to divest. It’s not a black-or-white decision.

REASSESS the relationships

MIGRATE the customers

RENEGOTIATE the value

proposition

EDUCATE the customers

TERMINATE the relationship

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Page 5: Manage Unprofitable Customers

The Right Way to Manage Unprofi table Customers

98 Harvard Business Review | April 2008 | hbr.org

database approximately 64,000 patients with

unpaid medical bills. After considering the social

impact of divesting them, Joan Richardson, then the

chief medical director at the 800-bed hospital, devel-

oped a plan for rationing care among these patients –

essentially, restricting them to certain drugs and proce-

dures and requiring that they pay up front for doctor visits.

The plan helped to reduce the facility’s percentage of non-

paying patients among the total care population from 26%

in 1998 to about 17% in 2003.

Another reason to divest is to increase employee produc-

tivity and morale. Unduly rude and habitually obnoxious

customers can impede employees’ ability to get their work

done and even their desire to stay with a company. Think

of a frequent diner at a restaurant, for instance, who spends

a lot on food and wine every evening but condescends to

the waitstaff and disturbs the other patrons. For the sake

of employee retention (and possibly to keep other profi t-

able customers in the fold), he’s got to go. Especially in B2B

services, executives risk increasing employee turnover and

losing institutional knowledge if troublesome customers are

not cut loose. An executive from a large service fi rm told us,

“It was a question of whether or not we wanted to keep our

employees. The client was working them too hard, and mu-

tiny was upon us. We value our people. We gently told the

client that we could no longer assist them.” A senior partner

at a research and consulting fi rm shared with us an anecdote

about a client in the consumer packaged-goods industry who

“was all about winning. [The clients] never felt they had won

until everyone else around them lost. Even if we gave them

the best product, they always had to fi nd some fault. It was

wearing us all down.” The partner brought these concerns

to the fi rm’s CEO, who ultimately decided the consultancy

would stop bidding on projects for this client.

Capacity constraints are a third reason for divesting cus-

tomers. Some companies lack the appropriate expertise,

physical capacity, or fi nancial resources to continue provid-

ing a particular service; others underestimate customer de-

mand or the effects of new regulations or environmental

forces. Partners in two accounting fi rms told us their institu-

tions divested themselves of hundreds of U.S. customers af-

ter passage of the Sarbanes-Oxley Act signifi cantly increased

the time that employees had to spend on compliance mat-

ters for large, publicly traded clients. “We simply don’t have

enough manpower to serve smaller, privately owned clients,”

one of the partners said. “Not that we want to, but we have

had to walk away from, raise fees for, or just not pay enough

attention to the smaller companies,” some of which were

driven away.

Finally, some companies view customer divestment as a

natural, if somewhat intentional, consequence of their evolv-

ing strategies. When organizations decide to stop offering

certain products and services, or when they exit entire busi-

ness segments, they’re indirectly telling customers

to fi nd other vendors that can meet their needs.

AT&T, for instance, decided in 2004 to focus more

on the commercial market and less on residential

customers. The company didn’t actively set out to

terminate relationships with individuals, but the com-

bination of natural attrition and some poaching by

competitors considerably reduced the company’s base of

residential customers.

Some organizations shed customers to correct for past

strategy miscues. One manager at a world-class telecom-

munications fi rm told us that during the late 1990s, his com-

pany had indiscriminately signed up large numbers of small-

business clients in an attempt to gain market share quickly.

By 2004, he said, many of those customers had either gone

out of business or proved to be unprofi table. He acknowl-

edged that the company is now paying for that landgrab: “It

has become a wrenching exercise in customer divestment,

internal job cuts, and reorganization.” Similarly, in response

to scandals and SEC investigations, insurance giant Marsh &

McLennan in 2005 jettisoned thousands of clients worldwide

after a long-overdue profi t audit showed that the company

was losing money on about 25% of its customer base. “The

short-term solution was obvious,” CEO Michael G. Cherkasky

told the Wall Street Journal. The company divested itself

of its unprofi table customers and of the employees who

supported them.

When Is Customer Divestment Risky?Firing your customers can make sense in certain situa-

tions, but more often than not the risks of such a strategy

outweigh the rewards. It’s not just profi ts that are at stake;

multiple constituencies are affected when businesses de-

cide to divest. Companies with high fi xed costs, for example,

risk placing more of the cost burden on their remaining

clients. A doctor we interviewed said after she dropped two

unprofi table patient segments, she had trouble fi lling the

empty slots in her schedule. Staffers sat idle, but she was

loath to fi re them – many had been with the practice a long

time. Eventually, this physician ended up buying another

practice to get her business back up to its original break-

even point. Companies that get rid of customers may lose

valuable sources of information, experimentation, and in-

novation. After all, end users’ ideas and suggestions can help

companies quickly identify new products and services and

develop best practices.

For their part, customers let go by one fi rm can usually

be accommodated by a rival company, thereby changing

the competitive dynamics. There was obviously no shortage

of phone service options for customers who felt displaced

by AT&T’s new focus on the commercial space, for instance.

However, in some scenarios, remaining customers may be-

come insecure and wonder whether they are next in line.

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hbr.org | April 2008 | Harvard Business Review 99

Sometimes customers can construe divestiture as a form

of discrimination, and they clearly are infl uenced by offers

to other customers. In 2000, for instance, Amazon received

bad publicity for its foray into dynamic pricing: It was of-

fering different customers slightly different discounts on

a particular product. When they found out, the customers

involved (as well as those who weren’t) were outraged, and

the company volunteered to issue refunds.

Frontline employees are not left unscathed when com-

panies shed their customers. As the Marsh & McLennan

case illustrates, a downsized customer base can lead to a

downsized employee base. For the remaining employees, the

sudden departure of clients who may also be friends can be

traumatic – after all, in most cases employees worked long

hours to acquire, nurture, and develop the now-broken rela-

tionships. At Marsh & McLennan, the frustrated and angry

brokers who weren’t fi red were so disgusted at how their

former clients and colleagues had been treated that they

defected to competitors. The lesson is that a company’s treat-

ment of its customers sends a powerful message – intended

or not – about how well management treats its employees.

Clearly, ethical and legal issues can arise when companies

decide to divest customers. Such a strategy may directly con-

tradict the principles of corporate social responsibility deeply

embedded in many organizations. Consider that citizens of

Western nations generally expect certain services (electric-

ity, water, sanitation, and heating) to be universal, regard-

less of one’s ability to pay. Then look at Embratel, a leading

phone service provider in Brazil: The high cost of debt col-

lection made the company want to stop serving customers

who hadn’t paid their bills in more than six months. Regula-

tory agencies blocked the move, however, citing hardships

for the masses. The telecommunications company later of-

fered these customers fi nancial incentives to cancel their

Embratel phone service and switch to prepaid calling cards.

Because differentiation and segmentation are the corner-

stones of most customer divestment programs, such ini-

tiatives may be perceived by regulators, activists, and con-

sumer watchdog groups as discriminatory – regardless of the

strength of the business cases behind them.

Managing the Divestment ProcessObviously, customers and fi rms must engage in a transac-

tion that is mutually benefi cial. However, this equitable ex-

change of value can be diffi cult to maintain over the long

term. Divestment creeps into management’s thinking when

the value provided to customers grossly exceeds the value

extracted. Nevertheless, this strategy should be exercised

only after carefully studying relationships with customers

in context and making every effort to restore equilibrium.

Our customer divestment framework can guide you through

that process (see the exhibit “How to Approach Customer

Divestment”).

Reassess the present customer relationship. First, ex-

ecutives should thoroughly review the information, be-

yond profi tability, that was used to identify an individual

or customer segment as a problem. That includes not only

fi nancial metrics, such as the customer’s current and future

spending, but also a broader view of the context in which

the customer and the company are operating. For example,

have the customer’s needs changed? Conversely, has the

company’s focus changed? Would the customer benefi t from

being switched to another service the company provides?

The way the company answers such questions will inform

its decision about whether to divest.

For B2B companies, such analysis is relatively easy to con-

duct because they typically have a narrow range of large

customers and lots of detailed information about the costs,

revenues, and profi tability of each. By contrast, B2C compa-

nies generally have indirect relationships with a broad range

of consumers and may lack qualitative and quantitative data

on each customer segment.

Sometimes companies will fi nd that they have misjudged

customers. Consumers who have been identifi ed as unwill-

ing to spend – and therefore unprofi table – may simply be

unaware of the range of services available. In other cases,

a customer’s unwillingness may be a by-product of the

company’s own myopia. That can happen in both B2C and

B2B environments. For example, in a bid to cater to its larger

Fortune 500 accounts, an advertising agency we studied was

paying less attention to its smaller clients in its portfolio,

particularly the local nonprofi t agencies, many of which

slowly started shifting their business elsewhere. The CEO of

the ad agency eventually took steps to reassess relationships

with these nonprofi t clients – but only after he got an earful

from a Fortune 500 client, who also happened to serve on the

board of one of the small nonprofi ts that was being ignored.

The CEO realized that the ad fi rm’s inadvertent divestment

of clients was tarnishing the company’s reputation and at-

tempted to renegotiate terms with these customers.

Companies that get rid of customers may lose valuable sources of information, experimentation, and innovation.

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The Right Way to Manage Unprofi table Customers

100 Harvard Business Review | April 2008 | hbr.org

Educate customers. A critical aspect of fostering profi table

relationships with customers is managing their expectations:

If customers have the information they need to navigate a

complicated product or service situation, they will have fewer

questions and less need to draw on the company’s valuable

resources. Managers therefore should consider the following

questions: What are customers’ relevant knowledge gaps,

and what is the best way to fi ll them? Instead of being candi-

dates for divestment, some customers may merely need to be

taught how to use the company’s prod-

ucts and services better and to interact

with company representatives effec tively.

Consider the situation at Fidelity Invest-

ments. A few years ago the fi nancial ser-

vices organization identifi ed a group of

low-margin customers who were making

a high number of service calls. Instead

of cutting ties with these customers, Fidel-

ity attempted to educate them about its

other lower-cost troubleshooting options.

Specifi cally, the company’s call center

representatives taught the customers to

use Fidelity’s automated phone lines and

website. If these customers still wanted

to talk with a service representative, the

phone system identifi ed them and routed

them to longer queues.

In the B2B space, educating unprof-

itable customers is often more feasible

than in the consumer space: A medical

equipment company we studied, for in-

stance, recognized that it was spending

a lot of time, money, and talent to travel

to hospitals and health care agencies in

order to fi x problems that arose when

clients used computer interfaces incor-

rectly. Most of the help calls turned out to

be coming from physicians who weren’t

comfortable with the machines. The

company offered training sessions and

thereby helped the doctors improve their

productivity while it increased the profi t-

ability of the business relationship.

Educated customers are less likely to

blame a company if their relationship

with it dissolves. Indeed, by exchang-

ing information about the relationship

itself, companies can better manage

consequent attributions and consumer

responses. Typically, such information is

easier to exchange in B2B settings than

in B2C settings because corporate cus-

tomers are more likely than consumers

to understand the cost, revenue, and profi tability implica-

tions of the relationship. The managers at a fi nancial services

company we studied, for instance, told us they often inform

potential customers up front, during the negotiation phase,

about exactly how they create value for the company – and

exactly which trigger points could tip the scales toward un-

profi tability. Customers are told, for example, about the min-

imum balances they need to maintain in different types of

investment accounts for this fi rm to serve them profi tably.

Renegotiate (don’t just communi-cate) the value proposition. Renego-

tiation is an outgrowth of the reassess-

ment and education processes and is

especially attractive in markets where

the company can offer different pric-

ing and service strategies for various

subsets of customers without affecting

its relationships with other customers.

For instance, brokers and mutual fund

companies such as Charles Schwab

and Fidelity can charge higher fees

How to Approach Customer Divestment

We’ve developed the following framework to help you objectively determine how unmanageable your problem customers really are. This guide encourages you to look beyond profi tability as you consider the strategic impact of customer divestment.

EDUCATE

Share the company’s perspective with customers.

QUESTIONS TO ASK■ What are the customer’s relevant

knowledge gaps? ■ What is the best way to educate this

customer? ■ What can the customer do to help in

the education process?

ACTIONS TO TAKE ■ Manage the expectations of custom-

ers so that they are more willing to adapt.

■ Encourage customers to participate in decision making and to offer feed-back on products or services.

IN PRACTICE Instead of cutting ties with low-margin, high-maintenance cust omers, Fidelity Investments educated them about its lower-cost troubleshooting methods. The company’s call center representatives taught customers how to use its website and its automated phone lines to manage their accounts.

REASSESS

Understand why the customer (or

customer segment) is being consid-

ered for divestment.

QUESTIONS TO ASK■ Do we truly know why this cus-

tomer seems to be unprofi table? Has buying decreased because of an unwillingness – or an inability – to spend, for example?

ACTIONS TO TAKE ■ Glean detailed information and

qualitative insights about customers’ attitudes and behaviors.

IN PRACTICE A large advertising agency took a closer look at the smaller, nonprofi t clients it considered unprofi table and realized it was mismanaging these relationships: The fi rm was allocat-ing most of its resources to larger, Fortune 500 accounts. The smaller cli-ents, feeling ignored, were spending less money with the fi rm and slowly drifting away.

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hbr.org | April 2008 | Harvard Business Review 101

to customers who conduct fewer transactions or maintain

lower account balances.

The critical aim of this part of the framework is for ex-

ecutives to explicitly engage B2B and B2C customers in a

dialogue about the value proposition. Executives need to

consider the following questions: Are we really negotiating

with customers or simply issuing dictates? Have we built

into the fi nal price all the secondary and tertiary benefi ts

we provide customers? Are our customers aware of the total

value proposition we offer? U.S. food service conglomerate

Aramark asked itself just those questions in 2006 when its

multiyear contract with Duke University was about to come

up for rebidding. According to published reports, Aramark

cited what it deemed unreasonable client requests in choos-

ing not to reenter the bidding process. Aramark ultimately

decided to walk away from the account, but that decision

came after months of discussion with school offi cials about

the issues raised by the university’s student dining board,

such as management turnover and food quality and variety.

Renegotiations in B2B markets typically involve long lead

times and comprehensive reviews of all facets of a relation-

ship. Indeed, rather than focus on product revenue alone,

some companies offer varying levels of technical support.

For instance, we studied a supplier of commercial dies for

heavy machinery that has started charging some unprofi t-

able clients extra for on-site service as part of a renegotiated

price structure. What could have been an obvious divest-

ment situation turned into a win-win scenario for the com-

pany and its customers.

Migrate customers. When conducting one-on-one talks

about how to change the value proposition is not a realistic

option – as is usually the case with B2C customers – or if

such discussions with B2B customers fail, companies can uni-

laterally reconfi gure the customer relationship. Specifi cally,

they can move clients to other channels, forms of payment,

or even to other subsidiaries or providers. (Again, this is

where companies’ earlier efforts to educate customers about

the corporate perspective may pay off.) Relevant questions

to ask include, What other offerings out there would better

serve this customer? Is the customer willing to move?

In 2006, satellite TV provider EchoStar created a prepaid

service option for B2C customers with bad credit histories,

RENEGOTIATE MIGRATE TERMINATE

Renegotiate the value proposition to achieve mutual benefi ts for the company and the customer.

QUESTIONS TO ASK■ Are we really negotiating or just

sending a one-sided message? ■ Have we built into our prices all the

secondary and tertiary benefi ts we provide our customers?

■ Are customers aware of our entire value proposition?

ACTIONS TO TAKE ■ Implement differential pricing and

service strategies. ■ Open the lines of communication

between the company and custom-ers (especially in B2B settings).

■ Present modular products and services that customers can mix and match.

IN PRACTICE A supplier of commercial dies for heavy machinery renegotiated contracts with unprofi table clients, charging them extra for on-site repair services that had previously been a standard contract feature.

Move the customer to a new pro-vider (a partner or a competitor), channel, or form of payment.

QUESTIONS TO ASK■ What offerings would better serve

this customer? ■ Is the customer willing to move? ■ Which partners would accept this

customer?

ACTIONS TO TAKE ■ Identify partners or subsidiaries in

the same category as alternatives for the customer.

■ Identify alternative providers, even rivals, in the same industry.

IN PRACTICE In 2006, satellite TV provider EchoStar created a prepaid service option for B2C customers with bad credit histo-ries, thus shifting them to a different form of payment.

Discontinue the relationship with

the customer.

QUESTION TO ASK■ Now that we have gone through the

preceding steps, how can we get the customer to buy in to the deci-sion to end the relationship?

ACTIONS TO TAKE■ Set up preconditions for divestment

with the customer. ■ Establish mutually agreed upon

schedules and benchmarks for moving toward divestment.

■ Encourage mutual reviews, which include feedback from and for the customer.

IN PRACTICE Several years ago, Texas power com-pany TXU, capitalizing on electricity deregulation, disconnected service to some late-paying customers and offered special perks to those who paid on time.

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102 Harvard Business Review | April 2008 | hbr.org

thus migrating them to a different form of pay-

ment. Law and accounting fi rms push the bulk

of the work for smaller B2B clients to junior

associates; partners perform only a cursory

review for accuracy. The general idea of all of

these migration strategies is not to engage in

a dialogue with customers about changing the

value created on both sides, as in the renegoti-

ation phase; it is simply to persuade customers

to use an entirely reconfi gured service level

that is compatible with the present value they

bring to the company.

Some companies will actively assist the di-

vested customer in making the transition to a

different company, often to a partner and some-

times to a competitor. In so doing, these busi-

nesses not only get rid of the problem cus-

tomer but also demonstrate the extra effort

that can help mitigate the customer’s nega-

tive reactions and fears about switching to an-

other service provider. The partner companies

or competitors may, for example, have a cost

structure that enables them to better serve the

divested customers. Most often, collaboration

with a partner is a judicious option for the di-

vesting company. For example, a large market

research fi rm we studied refers limited-scale

projects to smaller, specialized partner fi rms

with lower cost structures that suit such projects.

Conversely, if a smaller fi rm lacks the resources

for a large project, it may team up with a bigger

ally or simply refer the project to the big fi rm.

Terminate the customer relationship. If after trying all

of the above options, there is still no hope of continuing

transactions in a manner that offers enough value for both

sides, the company should end the relationship with the

customer. However, it must deliver the news in a way that

minimizes negative fallout for the company. The possibili-

ties are many, depending on the customer. Approximately

90% of the managers we interviewed in B2B environments

said they used direct, interpersonal methods to communi-

cate the decision. They started early, months before contract

renewal was scheduled, explaining the fi rm’s perceptions

about value and asking for a more equitable relationship

in the future. The key is to get customers to recognize that

these discussions – and even termination itself – are mutu-

ally benefi cial.

The situation can be vastly different in B2C scenarios. In

our survey, 80% of divested consumers reported feeling an-

gry, frustrated, or embarrassed about being cut off – and

reasonably so. In many cases their unhappiness could well

have been mitigated and the inevitable word-of-mouth fall-

out squelched. Indeed, 70% of the divested consumers in B2C

environments did not receive

any advance notice from the

fi rms that were cutting ties

with them. Moreover, about

half of those that received ad-

vance notice were informed

by mail rather than in person

or on a live phone call. Over-

whelmingly, the consumers

we interviewed said they

would have preferred to have

been notifi ed by a person,

even on the telephone.

Another study we recently

conducted suggests that con-

sumers pay very close attention to the reasons they are di-

vested and assign blame accordingly, either to the company

itself or to other external factors. Customers who thought

they were let go because, say, the vendor was facing competi-

tive pressure to alter its strategy were less likely to be angry

about divestment than were customers who thought the

company dropped them simply to increase profi ts.

• • •

The complex, ever-evolving relationship between a company

and its customers requires active management. Customers

are not commodities that can be acquired or disposed of at

will. They deserve better than a simplistic decision by man-

agement to either retain or reject them. Compromise op-

tions abound, and our framework is a logical one for explor-

ing them. Customer divestment is a viable strategic option,

but it must be exercised sparingly, mindfully, and cautiously.

Your customer base, even if unprofi table, is not a resource

your business can afford to squander.

Reprint R0804F

To order, see page 139.

Consumers pay very close attention to the reasons they are divested and assign blame accordingly.

The Right Way to Manage Unprofi table Customers

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