Wednesday, April 11, 2012

Managing Retention in Service Relationships
INSEAD Working Paper 2012/42/DS revised version of 2011/80/DS

In a repeat business context, past experiences with a service provider affect customers' decisions to renew their contract. How should a strategic firm manage personalized service effort over time to maximize the longterm value from each customer relationship? We propose a dynamic model that relies on behavioral theories and empirical evidence to capture the effect of past service experiences on service quality expectations, customer satisfaction, and retention. Although firms can benefit from managing service expectations at the beginning of a relationship, we find that varying service in the long run is not optimal. Behavioral regularities determine the structure of optimal service policies and limit the value of responsive service. Loss aversion expands the range of optimal constant policies, and explains why firms must deliver on customer expectations. However, if satisfying experiences are more salient then firms should constantly vary service levels. Loyal or high-margin customers need not warrant better service; those who anchor less on past service experiences do-provided that retention is improved by better past experiences. The effect of customer memory on service levels is determined by whether habituation or rather goodwill drives defection decisions.