Customers usually differ from each other on many factors – purchase rates, price sensitivity, switching costs, rationality, time to respond etc. – and these differences affect the dynamics of competition. The table below gives some illustrative characteristics for two distinct customer groups in the electricity market discussed in Briefing 57.
| Low users | High users | |
| Fraction of customers in each group | 0.7 | 0.3 |
| Quarterly usage | $400 | $600 |
| Price sensitivity (price difference for all customers to switch if not rational) | $50 | $100 |
| Switching cost | $10 | $50 |
| Rationality | 1.0 | 0.5 |
| Fraction acting each quarter on potential savings | 1.0 | 0.25 |
Figure 1 shows the implications for customer switching by each group resulting from a competitor’s entry worth $20 saving to low users ($30 to high users), followed by our response four quarters later with a price cut worth the same amount to each group. The rational and instantaneous response of low users results in us losing them all in quarter four when the competitor enters, but we recapture them all again when we cut price in quarter eight. Amongst high-use customers, in contrast, only a fraction is motivated to switch by the competitor’s entry, and their slow response results in most of that group still being with us when we cut price in quarter eight. Thereafter, we slowly recapture some high users.
Figure 1: Impact of price changes on differing groups of electricity consumers. (Click image to view larger)
This principle can be repeated for more groups to give a still-more exact view of market behavior. If necessary, the full variety of customers’ varying characteristics would be captured by repeating the attribute principles described in Chapter 5. But there are practical limits to extending the analysis too far. First, the causal structure encompassing multiple attributes would be complex, risking the introduction of errors into the model and making its results hard to understand. Second, such detailed complexity would need to be populated with realistic information across the whole spectrum of behavioral responses of customers. These are unlikely to be knowable with much certainty. It is therefore more feasible in practice to carry out careful, simplified customer segmentation than attempt to capture the detailed profiling of all attributes amongst the customer population.
Until next time…
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Customer groups in airlines
A simple view of the air travel market has leisure travelers, who just want to travel cheaply, and will put up with great inconvenience and very limited service to save a bit of money, and business travelers for whom convenience and service are important. This difference is matched by ‘low-fare‘ airlines and ‘full service’ airlines respectively. At the extreme, airlines like Ryanair use airports that may be nearly two hours travel from the city they claim to serve!
But it’s not so simple. Ryanair rival easyJet uses major city airports like Amsterdam Schiphol, and attracts many business travelers. Even Ryanair wins some business users, some of whom exploit the super-low fares by buying tickets for more than one departure time, then simply using whichever time fits their needs best on the day. Leisure travelers are more complicated too, with many people accepting slightly higher fares so as to avoid long-distance ground travel and other inconveniences or discomforts.
This briefing summarises material from chapter 7 of Strategic Management Dynamics, pages 462-464.
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