Managing Retention in Service Relationships

A Working Paper is the author's intellectual property. It is intended as a means to promote research to interested readers. Its content should not be copied or hosted on any server without written permission from publications. 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 long-term 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. The growth of the service sector has brought about a paradigm shift from managing transactions to managing customer relationships, with an increasing focus on retention as a driver of profitability (Jain 2005). In both business-to-consumer (B2C) and business-to-business (B2B) sectors, evidence suggests that a customer's assessment of the value of the relationship, as well as subsequent repa-tronage decisions are critically influenced by the dynamics of service experiences with the firm (Bolton et al. 2006; Gupta and Zeithaml 2006). Hence the question for firms is how service can be managed over time in order to capture the most value from each customer relationship. Practitioners have recognized the importance of managing a series of service experiences in repeated interactions. According to a recent McKinsey study (DeVine and Gilson 2010): " Every year companies have thousands, even millions of interactions with human beings, also known as customers. Their perceptions of an interaction are influenced by [.. .] the sequence of painful and pleasurable experiences. Companies care deeply about the quality of those interactions [.. .] Yet the application of behavioral science …