Saturday, February 16, 2008

Customer Acquisition Costs

I had been to the barbershop yesterday and it set me thinking about their customer acquisition costs. Here's an example -

If suppose, they get a new customer, who has never been to their saloon before, their tendency is to offer the best service in order to make the customer a regular customer. Now, lets assume that the customer becomes a regular. The Barber's interest is best served when they don't cut enough hair (so that you come back sooner).

There are a lot of other companies that have this conflict of interest. We know how new cable/internet subscribers get very good deals for the first few months, which go away after the first few months in the contract.

Question is - what is the commonality between these businesses that treat new customers better than existing ones ??

I posed this question to my friend Torsten, who is an economics major in Pittsburgh and got this response -

If treating new customers is costly (in the sense that it minimizes the business's utility), then one commonality could be that the businesses value a long-term business relationship, i.e. they accept high startup costs (or less profits) in exchange for making more profits with the customer over the long term.

Another commonality of such businesses could be get a foothold into a new market and getting some customers with which they can earn the trust of more potential customers ("look, we are working for IBM - if they trust us, you can do so, too). From the other extreme, a quasi-monopolist could be interested in deterring new market entrants. Say, the big existing car companies are meanwhile realizing that they have done too little on a global scale to capture the new up and coming lower and middle-income customer groups in developing countries. As a result, companies such as Tata are now introducing $2,000-3,000 cars, capturing a huge market.

However, this market deterrence does not necessarily work everywhere. Our former laundry guy in Palakkad was not known for the quality of his work, but no one could change to another laundry since these guys had contracts among themselves preventing them from doing business in each other's area.
Can you think of any other examples?

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