The True Value of a Lost Customer

Overlooking important social effects can lead companies to underestimate the value of their customers. That's the message of new research on lost customer value by John E. Hogan and Katherine N. Lemon, both assistant professors of marketing at the Carroll School of Management, Boston College, and Barak Libai, a senior lecturer in marketing at the Leon Recanati Graduate School of Business Administration, Tel Aviv University. In a report for the Marketing Science Institute, they offer a simple method for quantifying these effects.

Over the past 10 years, marketers have become increasingly sophisticated at using data on purchasing behavior and costs to determine each customer's worth. However, traditional models, by and large, have missed a crucial point: By focusing only on the purchasing behavior of individuals, they capture only part of what customers do. People don't just buy products and services, explains co-author Hogan; they also use them, talk about them, and serve as role models for potential purchasers. Taken together, these activities can significantly enhance the value of an individual to a firm.

While academics have long been aware of these social effects, the difficulty lies in figuring out how to measure their impact on profitability. To simplify their analysis, Hogan and his colleagues focus on how social interactions influence sales for whole product categories (ignoring brand-level effects). This makes it possible to distinguish between two types of lost customers: those who defect to another company and those who give up altogether on the product category, which they term “disadoption.”When a customer defects, the abandoned firm simply loses the value of potential purchases. However, when a customer disadopts, an entire category also loses a walking, talking billboard that could potentially encourage other consumers to try the product.

Traditional customer profitability models capture the impact of defection, but quantifying the financial effects of disadoption requires a different approach: The authors build on the Bass model of new product growth, which has come into use widely since its introduction in 1969. The basic Bass model relies on two parameters to explain how sales evolve. The first is the effect of “external” influences, such as mass media, on the rate of new product adoption; the second is the impact of “internal” or social influences, such as network effects, imitation and word-of-mouth.