Sunday, August 15, 2010
Prof. Sunil Gupta, Head of Marketing Department, Harvard Business School
An interview with Professor Sunil Gupta, Head of Marketing Department, Harvard Business School
Markathon: An engineering degree from IIT Delhi, MBA from IIM Ahmedabad and PhD in Marketing from Columbia University to Edward W. Carter Professor of Business Administration and Head of the Marketing Department at Harvard Business School. Please share with us some insights and learning’s that have played a defining role in your journey.
Sunil Gupta: The journey from IIT Delhi to Harvard Busness School has been amazing. Soon after IIT, I joined IIMA and then worked for two years at HMM marketing Horlicks and Boost. However, during these two years I felt uncomfortable with the way marketing decisions were made. My marketing director was a scholar at heart and he encoraged me to read research articles to dig deeper and try new things at my job. This encouraged me to apply for my PhD at Columbia. At that time I was not sure what a PhD was all about. I assumed it was an advanced MBA that would allow me to become a consultant and I almost ended up being one. But my advisor convinced me to try academia for a few years and I am eternally thankful to him for this suggestion.
I am absolutely convinced that life is a series of coincidences and it does not follow a fixed plan. The trick is to be open-minded and take advantage of the opportunities when they arise. Based on my personal experience I encourage my students and my children to follow their passion rather than simply following the crowd. My basic belief is that it does not matter what you do so far as you are the best in that field.
Markathon: Your concept of Customer Lifetime Value (CLV) serves as the building block of Customer based valuation of a firm. It assumes the profit margins from a customer and the retention rate of customers of the firm to be constant. How applicable this model is for companies having a wide range of product categories and decreasing customer loyalty, especially in developing markets like India?
Sunil Gupta: My interest in Customer Lifetime Value (CLV) and customer-based valuation of firm developed during the height of the dot-com days in late 1990s. At that time many new economy companies like Amazon and eBay had sky high stock prices. It was hard for finance experts to value these firms based on traditional valuation methods like discounted cash flow or P/E ratio since there was no cash flow to discount and there was no earnings or E!
My basic premise in developing this approach was that firms generate cash flow and profits from selling products to customers. So if we can estimate the value of one customer of Amazon as, say $100, and we know that Amazon has 30 million customers, we know that the value of its current customer base is $3 billion. Next, we can build a model to forecast growth of Amazon’s customer base, and we can estimate the value of its future customer base. Add these two and we have a fairly good estimate of the firm value.
As a starting point for estimating these models I assumed constant margin and constant retention rate, which implies that if a firm has a retention rate of 90% then it will have 90% of its original customer base after year 1, 0.9*0.9 or 81% by end of year 2, and so on. In other words, it assumes an exponential decay in a customer cohort. Clearly this was a simplifying assumption. We later show that it is straightforward to build complexities in the model where margins and retention rates change over time. So the basic concept with some adjustments in the model and its underlying assumptions can be used for Indian companies as well.
Markathon: In your book “Managing Customers as Investments”, you have proposed to create a business profit tree for finding the key customer objectives as a part of customer-based planning exercise. Can you please elaborate the ways in which this profit tree helps in taking decisions on investment on new & existing customers?
Sunil Gupta: A medical analogy perhaps best illustrates the fundamental idea here. A doctor does not prescribe you a medicine unless he has run tests and diagnosed the root cause of the problem. Yet, I have seen that too often companies are quick to allocate their scarce resources to a specific task or program without identifying the key bottleneck or the main problem. The business profit tree is one simple way to break down the big problem into its potential causes.
Majority of the companies today reward their sales team on the basis of new customer accounts. But, your analysis shows customer retention to have the largest impact on customer profitability. What do you think is the reason for such company practices and how do you see the same changing in near future?
Part of this is cultural. We all like to win new territories, get new clients, gain market share and launch new products. It is more fun to do this than defend existing base or tinker with old products. The other major factor is that it is easy to measure and give credit for a new account to a sales person. It is much harder to say if a current customer stays with the company due to the efforts of the sales person or some other factors.
The only way to change this behavior is to design new metrics that companies can monitor and use to reward their managers and sales teams. In the U.S. many companies have already embarked on this journey and are building more comprehensive measurement tools and compensation systems. I should note two caveats. First, complex metrics and opaque reward systems can cause confusion and send mixed messages to the sales force. So one needs to be very careful in designing them. Second, a focus on customer acquisition is not necessarily bad in some situations. For example, in new and growing markets such as the mobile phone market in India, it is important to establish a strong presence by acquiring a large customer base quickly. The CLV concept simply suggests that it is also important to focus on the quality of customers you acquire, not just the number of customers.
Markathon: In your opinion should a company facilitate customer learning? And how does customer learning help in the long term retention of the customer?
Sunil Gupta: It is certainly good for a company to encourage customers to learn about its products and services. Research studies show that when users learn and get comfortable in navigating the web site of a company, such as Amazon, they are very reluctant to switch to a competing site even if it is a mouse click away.
It is also useful for companies to help customers undertsand their own usage behavior even if it has a short-term negative impact on a firm’s profits. Mobile phone carriers in the U.S. were notorious for profiting from consumers overage fees – fees that consumers pay when they use minutes over and above the free minutes allowed under their monthly mobile plan (most U.S. customers do not use pre-paid service). These fees result from consumers not being able to estimate their own monthly usage behavior accurately. However, when consumers get their monthly bill, they are outraged and switch carriers. Over time, mobile carriers realized that the short-term benefit from these fees is small compared to the cost of losing customers and the associated cost of acquiring new customers. So many companies now help customers learn and understand their own usage behavior to avoid such fees. In the end you need to strike a balance between the value you provide to customers and the profits you generate from them. If the equation tilts too much in one direction or the other, things start going wrong.
Markathon: In your opinion are differentiated pricing strategies sustainable in the long-term and do they provide a source of competitive advantage to a company?
Sunil Gupta: Absolutely. Differentiated pricing or charging different prices to different customers for the same or slightly different products requires a deep understanding of customers, their needs and their willingness to pay. Airlines is one of the prime examples of such price discrimination. One study found that the price of a Coke bottle varied by as much as 3 times in the same city on the same day depending on where it was sold. Interstingly, the price was higher at a vending machine placed at the entrance of a train station compared to a vending machine placed at the exit point of the station. Companies that design software or information products usually build full version of their product first and then deliberately disable some functions (e.g., student version of a software) to sell it at a cheaper price.
Current technology allows companies to get more and more information about customers that allows them to customize products and services to individual needs and therefore price its service differentially. The competitive advantage to firms will therefore come from a continuous and better understanding of customers.
Markathon: In your article on “A Model of Consumer Learning for Service Quality and Usage”, you argue that the customers make most of their learning in the first few service encounters and therefore these needs to be managed strategically. Could you give an example of how the first few service encounters should be managed and should they necessarily different from the later encounters?
Sunil Gupta: AT&T recently changed its pricing policy for smartphone users. Unlike its previous plan where users of iPhones or Blackberrys could use unlimited data for a fixed monthly fee of $30, consumers now have to choose between two plans: 250 MB of data for $15 per month or 2 GB of data for $25 per month. Most consumers are not sure how much data they might consume but they will learn as they start monitoring their monthly usage. Our research article shows that this learning is quite rapid and it is in the best interest of companies to help consumers in this process since this leads to a win-win situation: customers are less frustrated with unexpected charges which lead to higher retention and better long-run profits for companies. In fact AT&T is doing exactly this by providing tools to consumers to monitor their usage.
Markathon: Will privacy concerns be a major factor in the further development of online social networks and will the customer satisfaction with these networks be affected due to these concerns?
Sunil Gupta: Privacy has already become a major issue for online social networks. In November 2007, Facebook started its Beacon program to track its users’ visits to external websites. Mark Zuckerberg of Facebook argued that it would provide valuable information to its users since people could benefit from knowing if their friends bought, for example, a dress from Bloomingdales. However, Facebook never got users permission to track their website visits and the program created a huge controversy and was later retracted.
There are ongoing discussions and debates about this issue where companies claim that getting consumers’ personal information will help them provide more useful products and ads to them, while privacy experts fear that private information can be easily misused. I think this debate will continue in the future and probably intensify as technology becomes more sophisticated in tracking our location through mobile phones, or our preferences from our website visits.
Markathon: Has the growth of networks like Facebook reached a plateau? If not where are the next 400 million users going to come from?
Sunil Gupta: Currently there are almost 5 billion mobile phones used in the world. As social networks such as Facebook intensify their presence in mobile, they are likely to gain a lot of new users, especially in emerging markets, who never had access to Internet.
Markathon: How will the rise of these networks influence marketing trends and will it cause a paradigm shift in marketing principles?
Sunil Gupta: Social networks are already having a huge impact on how consumers obtain information about products and how they make decisions. Consumers use Facebook Connect to learn what their friends are buying. They use user-generated sites such as Trip Advisor to learn other users’ experiences with hotels before selecting a hotel. Marketing practices have to evolve with this changing consumer trend where word-of-mouth and viral campaigns become more important than mass marketing.
Markathon: With such an extensive academic and corporate experience, what do you think are the major differences between academic knowledge and corporate practices? Could you suggest ways to bridge these gaps?
Sunil Gupta: At the risk of making a sweeping statement, I think that academics are generally very good in creating new conceptual frameworks and coming up with broad generalizations by connecting the dots across companies and industries. However they typically lack a good understanding of the organziational complexities, specific situation or context of a company, and the people issues inherently involved in implementing any decision. Practicing managers, on the other hand, are very good in exactly those issues where academics lack knoweldge. In other words, the two complement each other very well.
At Harvard Busness School we have a strong focus on bridging this gap where faculty are encouraged to be in touch with management practice through case writing and field research. We also actively recruit leading practitioners to become Professors of Managemt Practice to encourage this dialog. There is an increasing need to bridge this gap and I hope more schools take a proactive action in this direction.
The Two sides of Customer Value
Customer-based strategy recognizes two sides of customer value:
•Value which the company provides to the customers(Value to customers) – In terms of products and services
•Value which the customer pays back to company(Value of customers) – In terms of profits over time
As shown in figure this divides customers into four sets:
•Star Customers: A true win-win situation
•Lost Cause: Company should reduce investments in this set of customers or even drop them if it can’t increase profitability from them
•Vulnerable Customers: Most loyal ones, but at the same time highly exposed to competition
•Free Riders: They exploit the relationship with the company to the maximum extent