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Business Strategy Deters Unprofitable Customers

March 6, 2007

The next time you get frustrated with a business for being a bit sluggish with its service, you might be playing into its strategy, according to a management professor at UC Davis.

Hemant Bhargava of the Graduate School of Management says that companies wanting to deter unprofitable customers will intentionally create setbacks that impair the quality of service for those users. Netflix, America Online and FedEx have used this strategy, and it is common in the technology industries where firms offer all-you-can-eat pricing menus.

An expert in technology management and the information technology industry, Bhargava explains that this business model, known as the "damaged goods strategy," keeps high-end users from getting too much from a service.

He published an article detailing this strategy in Electronic Commerce Research and Applications in October 2004. But the strategy has become more prevalent and publicized in recent months.

Netflix, for example, has been in the news with revelations, and even a lawsuit, about this practice. With their monthly rate for unlimited rentals, Netflix would rather not have customers who rent upwards of, say, 20 movies a month, explains Bhargava. In such cases, Netflix will specifically route these customers' orders to more distant warehouses to delay delivery time, or will send movies that are not at the top of these customers' lists, he added.

"Targeting these customers with a system that's modified to be inefficient appears expensive in the short term and damaging to the quality of Netflix's service," says Bhargava. "But eventually it benefits the company by causing the unprofitable users to take their business elsewhere, which they couldn't do just by raising the monthly fee."

Another prime example of the damaged goods strategy, and one that Bhargava's article focuses on, is America Online's requirement of a connection manager.

AOL required this proprietary software, which was incompatible with many other Internet applications and slows down the connection speed. It discourages "power users" who would take advantage of its flat-rate unlimited usage plan, but does not affect lower-end users.

Bhargava says these tactics can be seen in the way that a courier service offers various levels of speed of delivery. For example, he says, research has shown that FedEx will often delay a package with standard shipping, leaving it in a warehouse for a couple of days in order to maintain the value of premium delivery.

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