YWCA Mobile Club shop visiting an anti-aircraft site somewhere in Britain, 1943 (Source: Wikimedia Commons)
Ideas for Leaders #249

Managing Customer Relations When Demand Exceeds Supply

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Key Concept

When demand outpaces inventory suppliers cannot fulfil everyone’s orders. Two academic researchers have developed a quantitative model that suppliers can use to make the right decisions on which orders to fill, and which to delay, while keeping the greatest number of customers happy in the short- and long-term.

Idea Summary

What happens when a business has more orders that it can fill? While the situation may seem to be a happy one, resolving the dilemma effectively is key to maintaining a happy and profitable customer base.

The decisions must thus be made carefully: which customers should be served first? The high-margin customers might seem the logical choice. But what about the customers who historically complain the loudest when they have to wait? Or what if the low-margin customers in the queue order more consistently than the high-margin customers?

To help suppliers make the most optimal allocation decisions, Professor Daniel Adelman of the University of Chicago’s Booth School of Business and Professor Adam Mersereau from the University of North Carolina’s Kenan-Flagler Business School developed a quantitative model that factors in the three fundamental ways that customers differ from each other:

  • Contributing margin: the profit that the supplier makes from a customer;
  • Demand volatility: a customer’s consistency or inconsistency in the frequency and amount of orders;
  • Customer memory: the sensitivity of a customer to past experience with the supplier.

Choosing the customers with the highest margins might make economic sense in the short-term. Such easy profit-taking, however, ignores the impact of goodwill on a supplier’s relationships with its customers and, ultimately, on that supplier’s long-term profitability. For example, if market conditions change, the low-margin customers neglected today might be essential for future profitability; however, their goodwill toward the supplier damaged by past experience, these customers are no longer around — they moved on to a more satisfying supplier.

This scenario highlights the importance of customer memory. Customers remember past service and this memory affects their ordering decisions. Customers with long memories will be willing to forgive an occasional less-than-stellar order fulfilment; customers with short memories, on the other hand, are more likely to complain — and leave.

The decision support model developed by Adelman and Mersereau factors in this key relationship between customer memory and demand volatility.

Business Application

The best strategy that emerges from the research is for the supplier to maintain and nurture a portfolio of customers who vary in margin, demand volatility and customer memory. The supplier can then manage the trade-offs between these three factors with the goal of keeping a relatively steady stream of orders coming from the entire customer base.

In this pool of customers, for example, will be customers with short memories — the squeaky wheels who if unhappy might retaliate with less future orders. The model indicates that stability is a key factor in keeping these customers happy and ordering. Suppliers must let the ultimate goal of stability — e.g. the same turnaround time for each order — in mind as they make their order fulfilment decisions concerning these types of customer.

Other customers, those with longer memories, might be more lenient or not as rigid in their expectations. These customers might be satisfied with less stability, within reason, of course.

One can see how a pool of customers with different expectations gives suppliers the flexibility they need to maintain the goodwill of all their customers. In a period of short supply, for example, it’s less risky to focus on fulfilling the orders of the customers with less memory and making the customers with longer memories wait a little longer. (One could say the model offers quantitative support to the old adage, “the squeaky wheel gets the grease.”)

The key is to manage the different customer expectations effectively. Given the complex dynamics involved, the model created by Adelman and Mersereau is the tool that suppliers need to keep the most people happy most of the time.

In short, suppliers should:

  • Avoid short-term profit-taking.  Such a strategy is myopic.
  • Recognize that different customers will have different expectations and understand what those expectations are.
  • Manage expectations carefully to ensure that the excessive expectations of some customers do not drown out the others.
  • Mix and match your fulfilment decisions in an attempt to meet the differing expectations of all customers.
  • Let the maintenance of long-term goodwill guide all decisions.
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Authors

Institutions

Source

Idea conceived

  • March 2013

Idea posted

  • October 2013

DOI number

10.13007/249

Subject

Real Time Analytics