customer retention paper dec 2005
TRANSCRIPT
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Sustainable Competitive Advantage Through Customer Retention:The Roles of Learning and Governance
SHANTANU DUTTAMarketing Department
Marshall School of BusinessUniversity of Southern California
RAMUMAR !ANA"RAMANMarketing Department
Marshall School of BusinessUniversity of Southern California
#$% !& MA#%R
University of Southern CaliforniaMarshall School of Business
Department of Management an' (rgani)ation *BR" +,-.$os Angeles/ CA 0,,102,1,1
Tel3 *45+. 145255657a83 *45+. 96,2+:14
e2mail3 kmayer;marshall&usc&e'u
Decem
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Sustainable Competitive Advantage Through Customer Retention:
The Roles of Learning and Governance
ABSTRACT3
Customer retention is an important issue for strategy scholars/ *B?. of the firm toe8amine the 'eterminants of customer retention& Using a uni@ue panel 'ataset of over a hun're'customer relationships of a large information technology firm/ >e are a thehistory of the transaction characteristics een the supplier an' their e fin' that customer retention is 'riven
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"n high technology in'ustries/ the increase' pace of glo capaork that suggests ho> the inter2organi)ational literature
on kno>le'ge/ learning/ an' governance impact the a
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customers in these markets it is important to separate the effects of characteristics of the current
transaction from the characteristics of previous transactions& (ur panel 'ata of customers ena. has focuse' on ho> the characteristics of the current transaction affect ho> it >ill they are governe'/ also play an important role in customer
retention& "n some cases >e fin' that characteristics of prior transactions play a greater role in
customer retention than the current transaction characteristics as customer concerns accumulate
over time& Customer retention is an important performance metric in ar's filling this
important gap&
Secon'/ our fin'ings are consistent >ith our conceptuali)ation of the impact that
kno>le'ge hen a supplierFs 'ecision to utili)e a su
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or'er to re'uce governance costs/ e e8amine circumstances >hen a supplier may hurt the
relationship >ith a customer of the role of governance on inter2organi)ational relationships& (ur
fin'ing suggests that e are the
first to e8amine the impact of governance choice on customer retention&
=e are a
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firms are reali)ing the importance of loyal customers an' a'opting strategies to create an'
sustain a loyal customer are in'ustry&
%8tant literature in marketing has looke' into the various aspects of customer
relationship& =hile some stu'ies are concerne' >ith formulating metho's to mo'el customer
retention *Schmittlein/ Morrison Colom
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7urther/ our stu'y also provi'es a sharper focus on ho> ole'ge *i&e&/
capaell ill promptly oill
likely un'ertake a''itional monitoring of the supplier to compensate for the >eak outcome2
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a''itional monitoring/ ho>ever/ the supplier >ill have some uncertainty ahether the oell the supplier has performe'& This shoul' result
in a lo>er likelihoo' of repeat hen the output of the current proect is'ifficult to measure&
%ven if the customer is satisfie' >ith the proect upon completion/ the 'ifficulty of
os that shirking on @uality is highly unlikely to ork/ may here output is 'ifficult to measure/ the less likely the customer is toreturn&
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A customerFs perception of the supplier is 'riven hen contracting pro upon transaction cost economics to e8amine the role of
governance in customer retention/ our focus on customer retention causes us to focus on an
e8planatory variaith the customer is likely to le'ge that asset specificity is important in governance/ e
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=hen a supplier >ins the to organi)e an' complete the proect& The supplier can use employees or turn to a
suith
employees for t>o key reasons that involve customer perception& 7irst/ the customer may
interpret the use of a suorking >ith the supplier in the future& %mployees are more
relia
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Hypothesis + assumes that customers have a clear an' imme'iate negative reaction to
su
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Hypothesis 63 The more of a particular customerFs prior mission critical proects that thesupplier has sule'ge consi'erations on organi)ational form *e&g&/ Argyres/
500- Nickerson Silverman/ 4,,+. an' competitive a'vantage *e&g&/ 7oss/ 500- ogut
an'er/ 5004./ its effect on customer retention has yet to oul' hurt
not only the customer oul' le'ge reuse effectively aligns the incentives of the customer
an' supplier/ >hich shoul' increase customer satisfaction an' retention&
A secon' factor is that some customers are more likely than others to >ork >ith suppliers
on proects that may generate reusale'ge& Some customers are closer to the
technological frontier than others& Many of the proects that can pro'uce potentially reusale'ge involve customers >ith cutting e'ge re@uirements& Such customers are likely to have
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future proects that >ill also pro'uce reusale'ge/ so the supplier has an a''e' incentive
to perform >ell in or'er to earn future ell in such situations/ customer satisfaction shoul' ith such strong incentives for
the customer/ the customer is likely to reap the repeate' ith a supplier feeling very
satisfie' >ith the supplierFs performance/ the more likely the ill return to the supplier 'ue
to the continue' pattern of superior performance&
A secon'/ an' perhaps more important/ effect is that the more times a proect involves
potentially reusale'ge/ the more e8perience the supplier gets in learning ho> to
incorporate such kno>le'ge an' use it to effectively meet the nee's of this an' other customers&
%8perience is a po>erful 'river of learning in organi)ations *e&g&/ Argote/ 5000.& =hile reusale'ge can
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Hypothesis -3 The more prior proects the supplier has complete' for the customerinvolving potentially reusale'ge/ the greater the likelihoo' of retaining thecustomer&
=hile potentially reusale'ge is important/ a secon' aspect of kno>le'ge an'
learning is a supplierFs e8perience >ith a particular customer& The longer a supplier >orks >ith a
particular customer in a given line of to >ork more
effectively >ith that customer an' the more the customer may come to trust the supplier& There
are four 'istinct reasons >hy e8perience >ith a customer is likely to increase customer retention&
7irst/ mistakes are more common on early proects orking together *Mayer Argyres/ 4,,6.& (nce the relationship survives these uncertainties
associate' >ith learning ahen a relationship een t>o firms is 'eveloping/
mistakes may oul'
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$)*#R#CAL A!AL+S#S
"ata and Conte,t
=e teste' the hypotheses >ith 'ata from Compustar/ a provi'er of a variety of
information technology *"T. services an' computer2relate' har'>are& The "T in'ustry is i'eal for
testing the hypotheses& "t is large an' important to customers in virtually all sectors of the >orl'
economy an' kno>le'ge is a key source of competitive a'vantage for "T firms& The "T in'ustry
involves the storage/ transfer/ an' management of information/ typically using mainframes/
servers/ or relate' 'evices& "t inclu'es three tiers3 customers *e&g&/ 7ortune :,, firms./ "T
suppliers *e&g&/ "BM/ 7uitsu/ CSC./ an' smaller su to fulfill
the proect re@uirements& The sourcing 'ecision is particularly important
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Compustar/ a pro'ucer of mainframes an' relate' har'>are since the 509,s/ entere' the
platform2in'epen'ent "T services le'ge
le'ge n from a
ran'om sample of the contracts in CompustarFs contracts lias selecte' oul' reflect the
entire population of proects& The proects in this sample consist of all contracts een
Compustar an' 564 customers& (ur sample contains appro8imately 4:G of the entire population
of Compustar "T services contracts& A revie> as representative of the full population of contracts in terms of customer in'ustries represente'/
si)e of the customer firm/ nume intervie>e' several Compustar managers/
engineers/ an' "T personnel from outsi'e Compustar& The 'ata >ere 'ra>n primarily from the
contracts een Compustar an' its customers/ su
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u'gment& The contract contains a 'etaile' 'escription of the proect inclu'ing the type of
service re@uire' an' the responsias e co'e' the customer as terminate' if that 'ate >as after the
en' of the sample perio'/ then the customer >as co'e' as right censore'& 7or customers that ha'
only single proect >ith Compustar/ >e use' t>o stan'ar' 'eviations aays of measuring
termination/ inclu'ing fi8e' perio's such as a year *see Ro
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is 'esigne' to capture the cost of measuring @uality e8 post ith high measurement costs& ER"(R
M%ASUR%M%NT C(ST is a count of the numith this customer that ha' high measurement costs&
Testing Hypotheses + an' 6 re@uires an interaction variaere suith
this customer& The current proect is not inclu'e' in this count&
The potential to create reusale'ge *Hypotheses :2-. is capture' hich is a 'ichotomous varia
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several others hat happene' 'uring the e8ecution of the proect& Hypothesis - e8amines the effect of prior
proects >ith potentially reusale'ge& ER"(R R%US% is a count of the nume inclu'e
customer critical proects/ regar'less of >hether they are suise& ER"(R CR"T"CA$ is a count of the num
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supplier an' it affor's the supplier the opportunity to learn more ale'ge among 'ivisions in or'er to provi'e s upon a technological area in
>hich the supplier has capaith e8perience2
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as as follo>s& %ach engineer co'e' the same eighty ran'omly
selecte' contracts& Then the t>o engineers an' one of the authors >ent through all eighty an' >e
foun' the follo>ing 'iscrepancies3 three for CR"T"CA$ SUBC(NTRACT/ three for
M%ASUR%M%NT C(ST/ t>o for ER(RAMM"N an' t>o for R%US%& After a ork/ the 'ynamics of 'uration time can hich is 'efine' as the customer iFs pro
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.5&&&*t
tOuntiliprelationshthecontinue'hascustomerthe
givent.t*t/intervaltimein theiprelationshthesterminateiPcustomerEr
$im.*,
+
=t
i th
The ha)ar' function can also hich it 'oes for our 'ata&
.:.&&&*e8p*.*.Q*5
, =
=p
j
jji xthxth
45
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*e8p *.25. helps us to interpret the coefficients associate' >ith the covariates& This represents
the percentage change in the ha)ar' rate for a unit change in the correspon'ing covariate/ 8&
Co8 *5094. presente' the semi2parametric partial likelihoo' function that is in'epen'ent
of the
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>ill as critical
for the customer& CompustarFs overall e8perience in the "T services in'ustry/ T"M%TR%ND/ has
a negative an' significant *p V ,&,,5. relationship on the likelihoo' of termination&
2222222222222222222222222222222"nsert Tahere it is 'ifficult to 'etermine @uality *CURR%NT
M%ASUR%M%NT C(ST. increase the pro
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*CURR%NT CR"T"CA$ SUBC(NTRACT. has no significant effect& Hypothesis 6/ ho>ever
receives strong support as the cumulative nume >ante' to con'uct a''itional
analysis to verify ho> a prior relationship influences customer retention& Mo'el 4 uses a linear
measure of prior relationship/ e thought that there might e inclu'e' *ER"(R "T ER(!%CTS.4in Mo'el +
to test for such a non2linear relationship& The log likelihoo' for Mo'els 4 an' + are 25++4&59 an'
25+49&41 respectively& Again/ the likelihoo' improvement een Mo'el 4 an' Mo'el + is
statistically significant at the 5G level& The =al' test reects Mo'el 4 in favor of Mo'el + *the
calculate' 4 +5&4- >hile the critical 4*54/ ,&,5. 4-&44.&
The s@uare' numhich provi'es stronger support for Hypothesis 5&
Robustness Tests
46
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"n or'er to test for the presence of multicollinearity an' roe
con'ucte' various tests& (ne such test is the variance inflating factor *?"7. test& "n general/ ?"7
value of less than 5, >oul' in'icate that there is no proas less than + >hich clearly in'icates that there is no proith a variety of 'ifferent >ays of 'etermining >hether the
last proect een Compustar an' each customer in the sample represente' a terminate'
relationship or a right censore' event& =e use' the follo>ing alternative measures to co'e
termination3 *5. t>o stan'ar' 'eviations ao theories that
shoul' influence customer retention are transaction cost economics *TC%. an' the kno>le'ge2
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that suill lea' to >orse
performance/ hen 'oes misalignment of the current transaction matter more an' >hen 'oes
history of misalignment pose a cumulative pro
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'ata 'ating ith the customer/ there is still a strong
increase in CompustarFs aith managing customer
relationships& Managing customer relationships is a ith t>o theoretical motivations& 7irst/ it coul' ith a learning an' governance
e8planation& The longer Compustar >orks >ith each customer/ the more they learn to >ork
together an' are likely to 'evelop customer2specific routines *e&g&/ kno>ing >hat to put in the
contract/ kno>ing >ho an' ho> to ask for changes. to make their interaction more efficient
*Mayer Argyres/ 4,,6.& These customi)e' routines represent a specific investment that >oul'
ere terminate'/ so the parties >ill re@uire a larger 'istur
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to resort to termination& Customer2specific learning can represent a specific investment that
influences customer retention&
=hile learning an' governance play important roles in customer retention/ so 'o
kno>le'ge consi'erations& =hile customer2specific e8perience resulte' in increase' retention/
>e also foun' that proects >here Compustar create' kno>le'ge that it coul' reuse also
increase' customer retention& =e attrihen Compustar is
ell ill make them more competitive in the future
le'ge& "n a''ition/ >e fin' a cumulative effect as the more
proects >ith the potential to create reusale'ge that Compustar 'oes >ith a particular
customer lea' to increase' customer retention& This result is consistent >ith an economic story
that increase' retention is a result of a supplier >ith strong incentives to perform >ell& "t also
consistent/ ho>ever/ >ith a more kno>le'ge2le'ge has the potential to
ith each customer& This e8planation is consistent >ith the
fact that our sample 'ates
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CompustarFs e8perience >ith that customer& The more pro'uct lines that the customer procure'
from Compustar/ outsi'e of "T services/ the greater CompustarFs ae
fin' that strong technological capaeak capaith mainframes an' their fle'gling capa
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supplierFs capae are confi'ent that the negotiate' contract 'oes not solely reflect
Compustar policy le'ge/ learning an' governance
consi'erations are important in virtually all B4B settings an' are not limite' to the "T services
in'ustries& 7or e8ample/ e8changes in many high technology in'ustries *e&g&/ aerospace/
telecommunications/ soft>are/ pharmaceuticals an' semicon'uctors. involve firms >ith 'iverse
kno>le'ge un'ertaking a series of comple8 proects that leverage firm2specific intellectual
property& 7uture research to confirm or 'iscount the generali)a
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relationships shoul' incorporate a measure of performance an' one such measure that 'oes not
re@uire 'etaile' financial 'ata is customer retention& =hile this measure is not perfect/ no
measure is/ >e ith the supplierFs performance&
"n a''ition/ >e e nee' to account for the past in or'er to
un'erstan' >hat is happening >ith the current e8change& Erior interactions can result in trust
*ulati/ 500:./ learning *Mayer Argyres/ 4,,6./ relationship2specific investment *=illiamson/
5005. an'Kor other effects that nee' to
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Holmstrom/ B& 5090& Moral Ha)ar' an' (
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=alker/ & $& Eoppo& 5005& Erofit Centers/ Single2Source Suppliers/ an' Transaction Costs&$dmini!trati&e Science /uarterl%/ 343 --219&
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=illiamson/ (&%& 501:& )conomic +n!titution! of Capitali!m& Ne> #ork/ N#3 The 7ree Eress&
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+:
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Table 0: "escriptive Statistics
?ariae ran severeal tests *inclu'ing ?ariance "nfaltion 7actor *?"7. test. in or'er to test for multicollinearity& ?"7 >as less
than +/ >hich in'icate that there is no pro
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Ta