Sustainable Competitive Advantage Through Customer Retention:

The Roles of Learning and Governance

SHANTANU DUTTA
Marketing Department
Marshall School of Business
University of Southern California
RAMUMAR !ANA"RAMAN
Marketing Department
Marshall School of Business
University of Southern California
#$% !& MA#%R
University of Southern California
Marshall School of Business
Department of Management an' (rgani)ation *BR" +,-.
$os Angeles/ CA 0,,102,1,1
Tel3 *45+. 14525565
7a83 *45+. 96,2+:14
e2mail3 kmayer;marshall&usc&e'u
Decem<er 5-/ 4,,:
Sustainable Competitive Advantage Through Customer Retention:
The Roles of Learning and Governance
ABSTRACT3
Customer retention is an important issue for strategy scholars/ <ut one that has receive' little
attention& =hile organi)ational scholars have e8amine' firm survival as a 'epen'ent varia<le in
a num<er of stu'ies/ the survival of an inter2firm 'ya' has <een neglecte'& =e 'ra> from
agency theory/ transaction cost economics an' the kno>le'ge2<ase' vie> *B?. of the firm to
e8amine the 'eterminants of customer retention& Using a uni@ue panel 'ataset of over a hun're'
customer relationships of a large information technology firm/ >e are a<le to assess ho> the
history of the transaction characteristics <et>een the supplier an' their <uyers impact customer
retention& Specifically/ >e fin' that customer retention is 'riven <y past actions at least as much
as actions that occurre' in the current transaction& By 'isentangling the effects of characteristics
of past an' present transactions <et>een the supplier an' their <uyers/ >e are a<le to offer a
nuance' insight to literature from agency theory/ transaction cost economics/ an' the B?& 7or
instance/ our fin'ing suggests that <uyers in this market are 'iscerning an' punish their suppliers
only >hen they o<serve a pattern of governance misalignment <ut 'isplay for<earance for one2
time mistake& This fin'ing highlights the importance of evolution of relationships on
organi)ational performance that coul' <e incorporate' in future TC% research& Similarly/ the
a<ility to reuse kno>le'ge gaine' from one proAect to other proAects enhances customer
retention/ as firms are utili)ing their learning from prior e8perience& These fin'ings also suggest
that managers nee' to carefully assess the nature of the transaction characteristics >ith their
customers to she' light on future customer <ehavior/ in particular retention&
5
"n high technology in'ustries/ the increase' pace of glo<ali)ation has le' to a rise in the
intensity of competition& As firms 'evelop skills in reverse engineering an' other means of
replicating technological innovations/ the a<ility to retain customers has <ecome increasingly
important for sustaina<le competitive a'vantage *Reichel'/ 500-B Cet)/ Blatt<erg D Thomas/
4,,5.& =hile there is a rich literature that has e8plore' ho> capa<ilities an' kno>le'ge *e&g&/
Argyres/ 500-B Hoetker/ 4,,:B ale/ Dyer D Singh/ 4,,4B Macher/ 4,,:B Henis) D Macher/
4,,6./ learning *e&g&/ Argote/ 5000. an' governance *e&g&/ Nickerson D Silverman/ 4,,+. impact
inter2organi)ational e8changes an' 'ifferent 'imensions of organi)ational performance *ale/
Singh D Eerlmutter/ 4,,,B Anan' D hanna/ 4,,,./ there has <een virtually no
conceptuali)ation an' evi'ence on ho> these factors impact customer retention&
=e 'evelop a conceptual frame>ork that suggests ho> the inter2organi)ational literature
on kno>le'ge/ learning/ an' governance impact the a<ility of a firm to retain its customers&
"nterestingly/ these theories are >ell suite' to she' light on customer retention in high2
technology in'ustries/ <ecause of the nature of transaction <et>een the <uyer an' their ven'ors
in these technology intensive markets& 7irst/ these customer2supplier transactions often entail
reliance on intangi<le kno>le'ge& Secon'/ the comple8ity of these activities often makes it har'
for customers to evaluate the @uality of the output& Thir'/ suppliers often ten' to outsource some
of the >ork to su<contractors& 7inally/ most of these <usiness customers often have repeate'
interactions >ith their suppliers&
This research makes three contri<utions to the literature on strategic management& 7irst/
>e 'isentangle the role playe' <y characteristics of prior transactions <et>een the customer an'
supplier as >ell as the role playe' <y characteristics of the current transaction to 'etermine their
effects on customer retention& Civen the repeate' nature of interactions <et>een suppliers an'
4
customers in these markets it is important to separate the effects of characteristics of the current
transaction from the characteristics of previous transactions& (ur panel 'ata of customers ena<le
us to 'o so& =hile prior >ork on transactional governance *see Shelanski an' lein *500:. for a
revie>. has focuse' on ho> the characteristics of the current transaction affect ho> it >ill <e
governe' *see Argyres an' $ie<eskin' *5000. for an e8ception./ >e sho> that the characteristics
of past transactions/ inclu'ing ho> they are governe'/ also play an important role in customer
retention& "n some cases >e fin' that characteristics of prior transactions play a greater role in
customer retention than the current transaction characteristics as customer concerns accumulate
over time& Customer retention is an important performance metric in <uyer2supplier
relationships an' >e kno> very little a<out it& This stu'y takes one step to>ar's filling this
important gap&
Secon'/ our fin'ings are consistent >ith our conceptuali)ation of the impact that
kno>le'ge <ase' vie> of the firm an' learning have on customer retention& "n particular/ >e fin'
that greater kno>le'ge ac@uire' through e8perience >ith a particular customer as >ell as greater
e8perience in the in'ustry enhance customer retention& 7urther/ >e fin' that >hen the supplier
completes more proAects >ith a specific customer that generates reusa<le kno>le'ge/ it provi'es
the supplier >ith very strong incentives to perform >ell in or'er to a'' to their kno>le'ge <ase
an' thus enhances customer retention&
Thir'/ our fin'ings are consistent >ith our conceptuali)ation of the impact that agency
theory an' transaction cost economics have on customer retention& "n particular/ the customerFs
a<ility to verify the @uality of the proAect also plays a key role in customer retention& 7urther/ >e
e8amine >hen a supplierFs 'ecision to utili)e a su<contractor can hurt customer retention&
=illiamson *509:/ 501:/ 500-. focuses on integration in the presence of contracting ha)ar's in
+
or'er to re'uce governance costs/ <ut >e e8amine circumstances >hen a supplier may hurt the
relationship >ith a customer <y using a su<contractor *i&e&/ effects of governance misalignment
*Mayer D Nickerson/ 4,,:..& Specifically/ >e fin' that >hen the supplier has a history of
outsourcing proAects that are critical to the customer/ then it has a negative impact on customer
retention& "nterestingly/ outsourcing Aust the current transaction 'oes not impact retention& This
fin'ing offers a nuance' vie> of the role of governance on inter2organi)ational relationships& (ur
fin'ing suggests that <uyers in these markets are strategic an' punish suppliers only >hen they
o<serve a cumulative pattern of outsourcing of critical proAects& To our kno>le'ge/ >e are the
first to e8amine the impact of governance choice on customer retention&
=e are a<le to test our hypotheses using a 'ataset of customer2supplier relationships from
the information technology *"T. services in'ustry& (ur 'ata consist of 6,: proAects from a large
"T services firm *hereafter kno>n as Compustar. in Silicon ?alley/ an' inclu'es a variety of
transaction attri<utes an' e8perience measures& The contracts 'ate from 501- to early 5001 an'
thus ena<le us to e8plore separately past as >ell as current transaction characteristics& These 6,:
contracts represent all the "T contracts <et>een Compustar an' 565 customers/ >hich allo>s us
to e8amine the 'rivers of customer retention arising from the characteristics of the transaction
an' the prior relationship <et>een Compustar an' the customer&
The follo>ing section 'iscusses prior >ork on customer retention an' >e then 'evelop
our hypotheses on ho> it is influence' <y learning an' governance& =e then 'escri<e our 'ata/
statistical metho's/ an' varia<les/ >hich are follo>e' <y the results/ 'iscussion an' conclusion&
BACKGRO!" A!" L#T$RATR$ R$%#$&
=hat 'ifferentiates companies in to'ayFs hyper2competitive an' 'eman'2'riven markets
is their a<ility to a''ress their customerFs preferences an' priorities& =ith increase' competition/
6
firms are reali)ing the importance of loyal customers an' a'opting strategies to create an'
sustain a loyal customer <ase *Cet)/ Blatt<erg D Thomas/ 4,,5.& The main o<Aective of the
customer relationship management *CRM. approach is to increase the life time 'uration of
customers <ecause of the un'erlying assumptions that long2term customers are more profita<le&
Reichhel'Fs *500-. stu'y >as one of the first to empirically 'ocument the relationship <et>een
lifetime an' profita<ility& He reporte' a significant increase in profits from small increases in
customer retention rates& 7or e8ample/ he sho>e' that as little as a :G increase in retention ha' a
significant impact on the net present value of the firm ranging from 0:G in the case of
a'vertising agencies to +:G in computer soft>are in'ustry&
%8tant literature in marketing has looke' into the various aspects of customer
relationship& =hile some stu'ies are concerne' >ith formulating metho's to mo'el customer
retention *Schmittlein/ Morrison D Colom<o/ 5019B Schmittlein an' Eeterson/ 5006B Reinart)
an' umar/ 4,,+./ other stu'ies are intereste' in stu'ying the 'rivers of customer retention such
as satisfaction *Bolton/ 5001. an' competitorsF offerings *Rust/ $emon D Heithaml/ 4,,6.&
Although these stu'ies help us un'erstan' the factors that influence customer retention/
these stu'ies have <een in <usiness to consumer settings *B4C. an' are focuse' on factors that
are most applica<le to customer retention an' management in a B4C setting& These stu'ies 'o not
account for important ven'orIcustomer transaction characteristics that coul' influence customer
retention& "n many B4B markets the same ven'ors an' customers ten' to >ork together
repeate'ly over time/ hence it is important to capture the characteristics of <oth the current
transaction as >ell as prior transactions& "n this stu'y/ >e focus on the characteristics of prior
transactions is important as it helps us un'erstan' ho> firms learn from their overall in'ustry
e8perience an' their e8perience >ith specific customers to offer <etter pro'ucts an' services&
:
7urther/ our stu'y also provi'es a sharper focus on ho> o<serva<ility of proAect performance an'
governance of previous proAects influences customer retention&
(ur frame>ork thus she's insight on the literature at the intersection of kno>le'ge *i&e&/
capa<ilities an' learning. an' governance& Buil'ing on e8aminations of alliance capa<ilities
*Anan' D hanna/ 4,,,B ale/ Dyer D Singh/ 4,,4. an' contracting capa<ilities *Argyres D
Mayer/ 4,,6./ this stu'y 'evelops a frame>ork to assess customer retention is also an aspect of
inter2firm governance in >hich firms can 'evelop capa<ilities&
TH%(R# AND H#E(TH%S%S
The Role of Observabilit' and Governance
Many of the transaction attri<utes that transaction cost research has sho>n to influence
vertical integration an' contract 'esign 'ecisions may also influence customer retention& (ne
transaction attri<ute that shoul' influence customer retention is the 'ifficulty of 'etermining the
@uality of the output of the proAect& Customers are more likely to return if the supplier performs
>ell on the proAect& =hen the @uality of output can <e easily measure'/ it creates strong
incentives for the supplier to perform >ell <ecause the customer >ill promptly o<serve any
failings& Measurement costs create a moral ha)ar' <y generating noise in the relationship
<et>een effort an' outcome *Holmstrom/ 5090.& "f any key 'imension of the output of the task
is 'ifficult to measure/ the supplier may have an incentive to shirk <ecause any failings in the
final pro'uct >ill <e 'ifficult to o<serve *An'erson/ 501:.& "n such cases the customer >ill
likely un'ertake a''itional monitoring of the supplier to compensate for the >eak outcome2<ase'
incentives *Holmstrom D Milgrom/ 5005B Mayer/ Nickerson D (>an/ 4,,6.& %ven >ith this
-
a''itional monitoring/ ho>ever/ the supplier >ill have some uncertainty a<out >hether the Ao<
has <een complete' correctly <ecause the @uality of the final pro'uct is 'ifficult to o<serve&
Thus proAects that result in output that is 'ifficult to measure are likely to result in
customers that are not completely sure ho> >ell the supplier has performe'& This shoul' result
in a lo>er likelihoo' of repeat <usiness compare' to proAects >ith clearly measura<le
performance criteriaJ<ecause such proAects provi'e stronger incentives for the supplier an'
allo> the customer to feel more secure >ith the outcome& %ven if the greater o<serva<ility
makes it clear that a mistake has <een ma'e/ the supplier can make the necessary corrections
until the customer is satisfie' >ith the result&
Hypothesis 53 Customer retention >ill 'ecrease >hen the output of the current proAect is
'ifficult to measure&
%ven if the customer is satisfie' >ith the proAect upon completion/ the 'ifficulty of
o<serving @uality in'icates that pro<lems may arise in the future& The pro<lem is compoun'e'
>hen the supplier completes multiple proAects >hose output is 'ifficult to measure for the
customer& The supplier kno>s that shirking on @uality is highly unlikely to <e 'iscovere'
imme'iately an' even if it is 'etecte' in the future/ there is often am<iguity over ho> the
pro<lem arose& Civen these >eakene' incentives/ the supplier may <e more likely to shirk the
more they continue to >ork >ith the customer& %ven if the supplier >ants to maintain a close
relationship >ith the customer/ their employees/ >ho are actually 'oing the >ork/ may <e a<le to
shave @uality to get the proAect complete' more @uickly an'Kor at lo>er cost& Thus measurement
costs create a pro<lem not Aust for the current proAect/ <ut represent an ongoing cumulative
pro<lem as more proAects >ith potentially latent pro<lems are complete' for the customer&
Hypothesis 43 The greater the num<er of prior proAects that a supplier has complete' >ith
a specific customer >here output is 'ifficult to measure/ the less likely the customer is to
return&
9
A customerFs perception of the supplier is 'riven <y more than Aust the a<ility to verify
the @uality of output& Transaction cost economics *=illiamson/ 501:/ 500-. hol's that using
employees is preferre' in situations >hen contracting pro<lems such as asset specificity are
present& There has <een some research on the governance choice2performance relationship *e&g&/
Masten/ Meehan D Sny'er 5005B =alker D Eoppo 5005B Silverman/ Nickerson D 7reeman
5009B Eoppo D Henger 4,,4.& Using market2<ase' governance/ such as su<contracting/ can hurt
performance if contractual ha)ar's are present *Mayer D Nickerson/ 4,,:B Nickerson D
Silverman/ 4,,+.& =hile >e 'ra> upon transaction cost economics to e8amine the role of
governance in customer retention/ our focus on customer retention causes us to focus on an
e8planatory varia<le that is very germane in the conte8t of <uyer2supplier relationships in these
in'ustries& "n particular/ >e assess ho> the nature of governance of pro'uctsKservices that are
critical to the <usiness of the customer impact customer retention&
5

Some proAects have limite' visi<ility an' mistakes that arise can <e fi8e' <efore they
cause serious pro<lems for the customer& Conversely/ pro<lems >ith other proAects can have an
imme'iate an' costly impact on the customer& "f a representative of the supplier *either a
su<contractor or employee. acts opportunistically or incompetently on a proAect >ith little
potential to harm the customer/ then the results >oul' <e em<arrassing for the supplier <ut the
customer might <e more forgiving since there >as no maAor harm 'one& "f the same type of
mistakes occur on a mission critical proAect that is very important to the customer/ ho>ever/ the
'amage to the supplierFs relationship >ith the customer is likely to <e much more severe& =hen
a customerFs critical applications or systems are involve' in a proAect/ suppliers may prefer to use
their o>n employees rather than su<contract the proAect to an outsi'e company&
5
=e certainly ackno>le'ge that asset specificity is important in governance/ <ut >e <elieve that since our focus is
on retention of <usiness customers/ governance of pro'uctsKservices critical to their <usiness may <e even more
important to these customers/ in mo'erating the relationship <et>een governance an' customer retentionJa
relationship not e8amine' to 'ate <y transaction cost researchers&
1
=hen a supplier >ins the <i' for a proAect >ith a customer/ the supplier must 'etermine
ho> to organi)e an' complete the proAect& The supplier can use employees or turn to a
su<contractor& EroAects that involve critical customer applications shoul' <e complete' >ith
employees for t>o key reasons that involve customer perception& 7irst/ the customer may
interpret the use of a su<contractor as a sign that the supplier 'oes not have any employees that
are @ualifie' to complete the task an' thus may 'ou<t the value a''e' <y the supplier& Secon'/
the customer may also feel that su<contracting their critical proAects is a sign that the supplier
may not take the customerFs important proAect very seriously&
"n a''ition to the customer perception issues/ there are t>o more reasons >hy a supplier
might >ant to avoi' su<contracting a customerFs critical proAect that relate to the likelihoo' of
pro<lems arising 'uring the proAect& 7irst/ su<contractors are unlikely to care as much a<out
future <usiness opportunities >ith the customer as the supplierFs employees/ >hose entire income
is linke' to the supplier& Secon'/ suppliers are <etter a<le to verify the training of employees an'
thus the risk that the >orker >ill <e incompetent is lo>er& "t can <e more 'ifficult to verify the
skills that a su<contractor has on his or her resume/ relative to its o>n employees/ as the firm
'irects the training of its employees an' has more e8perience >ith them than >ith outsi'e
su<contractors& Thus firms that try to use su<contractors >hen the proAect is critical for the
customer are more likely to encounter costly mistakes an' thus less likely to have a satisfie'
customer that >ants to continue >orking >ith the supplier in the future& %mployees are more
relia<le an' more likely to lea' to <etter proAect outcomes >hen contracting 'ifficulties cause'
<y mission critical proAects are present&
Hypothesis +3 =hen the supplier utili)es a su<contractor to complete a current proAect
that is mission critical for the customer/ the customer is less likely to return&
0
Hypothesis + assumes that customers have a clear an' imme'iate negative reaction to
su<contracting the current proAect an' 'onFt give the supplier another chance& Not all customer
critical proAects that are su<contracte'/ ho>ever/ >ill lea' to maAor pro<lems 'uring the proAect&
Customers may <e >illing to overlook some issues as the relationship 'evelops&
=hile su<contracting a current customer critical proAect is likely to have a negative effect
on customer retention/ there is also likely to <e a cumulative effect& "t may <e that customers
'onFt imme'iately leave if the supplier uses a su<contractor for one of their critical proAects/ <ut
instea' customers leave if they see a pattern of this type of activity <y the supplier& This is also
consistent >ith the foun'ations of transaction cost economics *e&g&/ =illiamson/ 501:./ >hich
asserts that <a' governance 'ecisions >ill result in cumulative effects that >ill harm the firm&
=hen critical proAects are su<contracte' <y the supplier over time the customers <ecomes
increasingly likely to lose confi'ence in the supplier/ lea'ing to lo>er retention& Customers may
not react if it only occurs onceJthere is no knee Aerk reactionJ<ut >ait to see if this activity is
an anomaly or a pattern& (utsourcing one critical proAect may <e for a goo' reason/ <ut a history
of it lea's the customer to @uestion the supplierFs internal competence *the in'epen'ent value the
supplier a''s. an' the supplierFs priorities& The customer may <elieve that continual
su<contracting of mission critical proAects in'icates that the supplier 'oes not 'eem the
customerFs proAect of sufficient importance to use their employees *i&e&/ the supplier is not paying
enough attention to the customer. 'espite the importance of these proAects to the customer&
The mere fact that a proAect is critical to the supplierFs <usiness is not likely to influence
retention/ <ut a series of critical proAects that are outsource' over time has a negative impact on
the customerFs perception of the supplierFs performance& This is likely to <e especially true in
B4B markets >here the customers are also kno>le'gea<le <usinesses&
5,
Hypothesis 63 The more of a particular customerFs prior mission critical proAects that the
supplier has su<contracte'/ the less likely the customer is to return&
The Role of Kno(ledge and Learning
The kno>le'ge2<ase' vie> of the firm *B?. *e&g&/ ogut D Han'er/ 5004. has focuse'
attention on kno>le'ge consi'erations/ >hich can also affect customer retention& =hile the
B? has e8amine' the effect of kno>le'ge consi'erations on organi)ational form *e&g&/ Argyres/
500-B Nickerson D Silverman/ 4,,+. an' competitive a'vantage *e&g&/ 7oss/ 500-B ogut D
Han'er/ 5004./ its effect on customer retention has yet to <e e8plore'& Some proAects have little
kno>le'ge impact on the firmJthe supplier completes one proAect an' moves on to the ne8t&
Some proAects/ ho>ever/ can influence the cost of future proAects <ecause the kno>le'ge
generate' to complete the first proAect can <e reuse' for future proAects& EroAects that may create
potentially reusa<le kno>le'ge may increase customer retention for t>o reasons&
7irst/ >hen the proAect represents a potential key a''ition to the supplierFs kno>le'ge
<ase/ then the supplier >ill <e highly motivate' to complete the proAect >ith high @uality& The
supplier has little incentive to shirk on @uality or effort as a successful proAect <enefits not only
the customer/ <ut a''s to the supplierFs kno>le'ge <ase as >ell& Shirking on @uality >oul' hurt
not only the customer <ut also the supplier <ecause the kno>le'ge create' >oul' <e of less
value& Thus the potential for kno>le'ge reuse effectively aligns the incentives of the customer
an' supplier/ >hich shoul' increase customer satisfaction an' retention&
A secon' factor is that some customers are more likely than others to >ork >ith suppliers
on proAects that may generate reusa<le kno>le'ge& Some customers are closer to the
technological frontier than others& Many of the proAects that can pro'uce potentially reusa<le
kno>le'ge involve customers >ith cutting e'ge re@uirements& Such customers are likely to have
55
future proAects that >ill also pro'uce reusa<le kno>le'ge/ so the supplier has an a''e' incentive
to perform >ell in or'er to earn future <usiness from such valua<le customers& Both factors
provi'e the supplier >ith strong incentives to perform >ell on proAects that may pro'uce reusa<le
kno>le'ge&
Hypothesis :3 =hen the current proAect is likely to generate kno>le'ge that the supplier
can reuse/ customer retention shoul' increase&
EroAects >ith potentially reusa<le kno>le'ge shoul' have a lasting effect on customer
retention& Customer retention shoul' increase as the supplier 'oes more proAects >ith the
potential to create reusa<le kno>le'ge for a particular customer& Civen the supplierFs strong
incentives to perform >ell in such situations/ customer satisfaction shoul' <e high each time
such a proAect is complete'& As the supplier 'oes more proAects >ith such strong incentives for
the customer/ the customer is likely to reap the repeate' <enefits of very positive supplier
performance& The more times a customer finishes an interaction >ith a supplier feeling very
satisfie' >ith the supplierFs performance/ the more likely the <uyer >ill return to the supplier 'ue
to the continue' pattern of superior performance&
A secon'/ an' perhaps more important/ effect is that the more times a proAect involves
potentially reusa<le kno>le'ge/ the more e8perience the supplier gets in learning ho> to
incorporate such kno>le'ge an' use it to effectively meet the nee's of this an' other customers&
%8perience is a po>erful 'river of learning in organi)ations *e&g&/ Argote/ 5000.& =hile reusa<le
kno>le'ge can <e <roa'ly applie' across many of the supplierFs customers/ it is clearly
applica<le to future proAects from the same customer& Thus the supplier <enefits from learning
ho> <est to re'eploy the kno>le'ge more generally across the customer <ase/ an' from a higher
likelihoo' of <eing a<le to reuse the kno>le'ge again >ith the same customer&
54
Hypothesis -3 The more prior proAects the supplier has complete' for the customer
involving potentially reusa<le kno>le'ge/ the greater the likelihoo' of retaining the
customer&
=hile potentially reusa<le kno>le'ge is important/ a secon' aspect of kno>le'ge an'
learning is a supplierFs e8perience >ith a particular customer& The longer a supplier >orks >ith a
particular customer in a given line of <usiness/ the more the supplier learns ho> to >ork more
effectively >ith that customer an' the more the customer may come to trust the supplier& There
are four 'istinct reasons >hy e8perience >ith a customer is likely to increase customer retention&
7irst/ mistakes are more common on early proAects <ecause they parties may have
misaligne' e8pectations or they may make honest mistakes relate' to their ine8perience at
>orking together *Mayer D Argyres/ 4,,6.& (nce the relationship survives these uncertainties
associate' >ith learning a<out one another/ the likelihoo' of the customer terminating the
relationship shoul' 'ecrease& Secon'/ >hen a relationship <et>een t>o firms is 'eveloping/
mistakes may <e more 'ifficult to interpret& 7or e8ample/ suppose that the supplier <elieves the
customer >ants one thing/ <ut the customer really >ante' something else that is more comple8
an' costly& The customer may not <e sure if the supplier simply ma'e a mistake or is trying to
shirk&
Thir'/ e8perience >orking together may in'icate that trust is 'eveloping *Culati/ 500:.
an' trust <et>een firms shoul' <e positively relate' to customer retention *Cannon D Eerreault/
5000B Ceyskens et al/ 500-.& 7ourth/ from a transaction cost perspective/ the more fre@uently
that a supplier an' customer >ork together/ the more likely that they >ill invest in relationship2
specific routines& These routines may ena<le the firms to an' interact more effectively& Thus the
customer >oul' <e more likely to return to take a'vantage of such investments&
Hypothesis 93 Customer retention >ill improve as the firm gains more e8perience
>orking >ith a particular customer in the current line of <usiness&
5+
$)*#R#CAL A!AL+S#S
"ata and Conte,t
=e teste' the hypotheses >ith 'ata from Compustar/ a provi'er of a variety of
information technology *"T. services an' computer2relate' har'>are& The "T in'ustry is i'eal for
testing the hypotheses& "t is large an' important to customers in virtually all sectors of the >orl'
economy an' kno>le'ge is a key source of competitive a'vantage for "T firms& The "T in'ustry
involves the storage/ transfer/ an' management of information/ typically using mainframes/
servers/ or relate' 'evices& "t inclu'es three tiers3 customers *e&g&/ 7ortune :,, firms./ "T
suppliers *e&g&/ "BM/ 7uAitsu/ CSC./ an' smaller su<contractors& The suppliers perform a variety
of "T proAects for their customers inclu'ing 'esigning customi)e' soft>are systems/ up'ating an'
maintaining e8isting soft>are or har'>are systems/ an' assisting >ith net>ork 'esign an'
security& The technological areas in this in'ustry inclu'e "BM2compati<le mainframes/ (SK+0,
programming/ Sun servers/ 'ata<ases *e&g&/ (racle/ "nformi8./ customi)e' soft>are support/ an'
'evelopment in a variety of languages& Capa<ilities in this in'ustry are technology2specific
rather than firm2specific/ >hich means that su<contracting options are almost al>ays availa<le&
=ork is performe' pre'ominantly on a proAect <asis& Customers i'entify an "T proAect
an' then secure resources to complete it& %ach proAect is source' separately& A customer may
engage "BM for one proAect an' CSC for another/ an' these suppliers must 'eci'e ho> to fulfill
the proAect re@uirements& The sourcing 'ecision is particularly important <ecause mem<ers of
the proAect team >ill likely interact 'irectly >ith the customer as the >ork is typically performe'
at the customerFs site& "n many cases/ in'epen'ent su<contractors are utili)e' to fulfill proAects
for customers&
56
Compustar/ a pro'ucer of mainframes an' relate' har'>are since the 509,s/ entere' the
platform2in'epen'ent "T services <usiness
4
in the mi'2501,s/ an' <y 5009/ its "T services
'ivision accounte' for revenues of appro8imately L5,, million >orl'>i'e& This gro>th >as
accomplishe' through the 'evelopment of an internal 'elivery force an' the use of a variety of
su<contractors& Compustar >as an i'eal firm for testing our hypotheses <ecause of its e8tensive
presence in several sectors of the "T in'ustry/ the significant value it place' on its kno>le'ge
<ase as a source of competitive a'vantage an' the variety of its kno>le'ge <ase& These
characteristics are typical of large "T firms such as "BM/ CSC/ %DS/ etc&
Compustar provi'e' access to all "T service contracts in its corporate contracts li<rary&
The contracts 'ate from 501- to early 5001& "n this stu'y/ >e analy)e a sample of 6,: of
CompustarFs "T contracts >ith North American customers& The contracts >ere 'ra>n from a
ran'om sample of the contracts in CompustarFs contracts li<rary& The sample >as selecte' <ase'
on the first letter of the customerFs name to generate an un<iase' sample that >oul' reflect the
entire population of proAects& The proAects in this sample consist of all contracts <et>een
Compustar an' 564 customers& (ur sample contains appro8imately 4:G of the entire population
of Compustar "T services contracts& A revie> <y Compustar personnel in'icate' that our sample
>as representative of the full population of contracts in terms of customer in'ustries represente'/
si)e of the customer firm/ num<er of contracts <et>een Compustar an' the firm/ etc&
"n a''ition to rea'ing the contracts/ >e intervie>e' several Compustar managers/
engineers/ an' "T personnel from outsi'e Compustar& The 'ata >ere 'ra>n primarily from the
contracts <et>een Compustar an' its customers/ su<contractor invoices/ an' other recor's
inclu'e' in the contract file& Compustar personnel co'e' any varia<le that re@uire' su<Aective
4
Elatform2in'epen'ent means that the firm supplies services to firms using a variety of 'ifferent types of har'>are&
These services inclu'e' net>ork support/ programming/ 'ata migration/ etc&
5:
Au'gment& The contract contains a 'etaile' 'escription of the proAect inclu'ing the type of
service re@uire' an' the responsi<ilities of the parties& "t is typically a<out five pages long an' is
'esigne' to accomplish a specific task for the customer&
%ariables
The 'epen'ent varia<le/ T%RM"NAT"(N/ is co'e' as one if the customer 'oes not return
to Compustar *i&e&/ if it terminates the relationship.& The main 'ecision in co'ing this varia<le
>as ho> to co'e the last proAect in the sample <et>een Compustar in each customer& Some
o<servations >ill <e right censore'Ji&e&/ the customer is still active >hen the sample en'sJ
>hile others >ill have terminate' the relationship prior to 5001& =e use' a variety of techni@ues
*see the Ro<ustness Tests section <elo>. an' finally settle' on the follo>ing proce'ure& =e
create' an average time <et>een proAects for each customer that ha' multiple proAects& =hen >e
got to the last proAect for each customer/ >e a''e' t>o stan'ar' 'eviations a<ove that average to
'etermine >hen >e coul' confi'ently say the customer >as not coming <ack& "f that 'ate *the
last proAect plus the mean time <et>een proAects plus t>o stan'ar' 'eviations. >as <efore the
en' of the sample perio'/ then >e co'e' the customer as terminate'B if that 'ate >as after the
en' of the sample perio'/ then the customer >as co'e' as right censore'& 7or customers that ha'
only single proAect >ith Compustar/ >e use' t>o stan'ar' 'eviations a<ove the entire sample
average to make the same 'etermination& (ur results are ro<ust to 'ifferent >ays of measuring
termination/ inclu'ing fi8e' perio's such as a year *see Ro<ustness Tests <elo>.&
The a<ility to o<serve @uality is the su<Aect of Hypotheses 5 an' 4& The varia<le
CURR%NT M%ASUR%M%NT C(ST captures >hether the technology employe' in the current
proAect makes it 'ifficult to 'etermine the @uality of the output generate' <y the proAect team& "t
5-
is 'esigne' to capture the cost of measuring @uality e8 post <ase' solely on the technological
nature of the proAect& Compustar stipulate' that the measurement cost varia<le <e co'e' <y its
engineers as a 'ummy varia<leB one if @uality is 'ifficult to 'etermine an' )ero if it is rea'ily
apparent& The @uestion that 'etermine' the value of this varia<le >as >hether a <rief/
ine8pensive test or inspection coul' 'etermine the @uality of the >ork 'one on the proAect&
Hypothesis 4 e8amines the effect of prior proAects >ith high measurement costs& ER"(R
M%ASUR%M%NT C(ST is a count of the num<er of prior proAects/ not inclu'ing the current
one/ >hich Compustar has complete' >ith this customer that ha' high measurement costs&
Testing Hypotheses + an' 6 re@uires an interaction varia<le to e8amine the effect of
customer critical proAects that are su<contracte'& CURR%NT CR"T"CA$ SUBC(NTRACT is a
'ummy varia<le that is one if the current proAect involves a customer critical proAect that is
su<contracte' <y Compustar& Customer critical proAects are proAects that have the potential to
cause a Msignificant portionN of a customerFs 'ata center to shut 'o>n& Such 'isruptions are
e8tremely costly an' 'isruptive to the customer& Compustar engineers co'e' this varia<le <ase'
on their e8pertise an' the 'escription of the proAect in the contract& The recor's in the contract
file in'icate >hether a su<contractor >as use' on the proAect& Hypothesis 6 e8amines the effect
of prior critical proAects that >ere su<contracte'& ER"(R CR"T"CA$ SUBC(NTRACT is a
count of the num<er of prior customer critical proAects that Compustar has su<contracte' >ith
this customer& The current proAect is not inclu'e' in this count&
The potential to create reusa<le kno>le'ge *Hypotheses :2-. is capture' <y CURR%NT
R%US%/ >hich is a 'ichotomous varia<le that is one if the proAect is likely to pro'uce reusa<le
kno>le'ge an' )ero other>ise& Compustar provi'e' t>o engineers to help >ith co'ing varia<les
that coul' not <e 'irectly co'e' from the contracts& The engineers co'e' this varia<le an'
59
several others <ase' upon their e8pertise an' recor's in the contract file& R%US% >as co'e'
looking only at the 'escription of the proAect in the contract& The engineers 'i' not investigate to
see >hat happene' 'uring the e8ecution of the proAect& Hypothesis - e8amines the effect of prior
proAects >ith potentially reusa<le kno>le'ge& ER"(R R%US% is a count of the num<er of prior
proAects that Compustar has complete' >ith this customer that ha' potentially reusa<le
kno>le'ge& The current proAect is not inclu'e' in this count&
Hypothesis 9 e8amines customer2specific e8perience an' learning& "ntervie>s in'icate'
that the 'evelopment of a customer relationship can <e measure' <y the fre@uency of interaction
<et>een Compustar an' the customer& $ength of interaction >as reAecte' as a pro8y for this
effect <ecause a customer may utili)e Compustar once an' then not use them again for several
years& Thus several proAects un'ertaken over a three year span in'icate a much more active an'
>ell2'evelope' relationship than fe>er proAects over a longer perio'& ER"(R "T ER(!%CTS is
the num<er of previous "T proAects Compustar has performe' for each customer& =e co'e' this
varia<le <y e8amining the full contracting file for each customer&
To isolate the effect of customer critical proAects that are su<contracte'/ >e inclu'e
customer critical proAects/ regar'less of >hether they are su<contracte'/ in the ha)ar' mo'el to
ensure that the relevant effect is su<contracte' critical proAects an' not Aust critical proAects&
CURR%NT CR"T"CA$ is co'e' as one if the current proAect is critical to the customer an' )ero
other>ise& ER"(R CR"T"CA$ is a count of the num<er of prior "T proAects that Compustar has
'one for the customer that >ere critical to the customer& The current proAect is not inclu'e' in
this count&
There are other factors that may influence customer retention& 7or e8ample/ the <rea'th
of <usiness that the customer 'oes >ith the supplier may <e an in'icator of satisfaction >ith the
51
supplier an' it affor's the supplier the opportunity to learn more a<out the customer& The
supplier can share kno>le'ge among 'ivisions in or'er to provi'e <etter overall service to the
customer& BR%ADTH is the num<er of the supplierFs pro'uct lines/ outsi'e of information
technology services/ that the customer <uys from Compustar& =e e8pect a <roa'er relationship
<et>een the firms to increase customer retention&
Another set of factors that can affect customer retention are the supplierFs technical
capa<ilities *Argyres/ 500-B Eeteraf/ 500+.& =hen a proAect 'ra>s upon a technological area in
>hich the supplier has capa<ilities that are superior to competitors/ customer retention may
increase <ecause the pro<a<ility of a pro<lem on the proAect shoul' <e lo>er <ecause competence
pro<lems are less likely to occur& Compustar engineers are ackno>le'ge' e8perts at servicing
mainframes from other ven'ors 'ue to their e8perience an' training in all aspects of mainframe
technology& Compustar has 'esigne' an' manufacture' mainframes since the 509,s an' has
'evelope' very strong capa<ilities in this areaJmainframes are CompustarFs primary pro'uct&
MA"N7RAM% is co'e' as one if the contract involves >orking on a mainframe computer an'
)ero other>ise& %8ternal in'ustry e8perts verifie' CompustarFs capa<ilities in this area& "n
a''ition/ this measure is in line >ith e8perience2<ase' measures of capa<ilities/ <ecause
Compustar so many years of mainframe e8perience *an' less e8perience in areas such as
programming.&
=hen a proAect 'ra>s upon a technological area in >hich the supplier has capa<ilities
that are >eaker than competitors/ customer retention may 'ecrease <ecause of the increase' risk
that the supplier >ill make a mistake <ecause they lack superior capa<ilities& There are many
other firms that possess programming capa<ilities/ >hich have not <een part of CompustarFs
focus over the past t>enty years& Erogramming capa<ilities are highly speciali)e' an' comple8/
50
<ut are technology2specific *e&g&/ (racle 'ata<ases/ Uni8/ (SK+0,. rather than firm specific&
ER(CRAMM"NC is a 'ummy varia<le that is one if the proAect primarily involves
programming an' )ero other>ise& CompustarFs capa<ilities in >orking on these proAects are not
superior to those of several other firms in the in'ustry&
%8perience in the in'ustry may also affect customer retention& Compustar may get <etter
at customer retention over time& T"M%TR%ND is a linear time tren' that is co'e' )ero for 501-/
one for 5019/ an' so on up to t>elve for 5001 an' is inclu'e' in all mo'els&
The co'ing process >as as follo>s& %ach engineer co'e' the same eighty ran'omly
selecte' contracts& Then the t>o engineers an' one of the authors >ent through all eighty an' >e
foun' the follo>ing 'iscrepancies3 three for CR"T"CA$ SUBC(NTRACT/ three for
M%ASUR%M%NT C(ST/ t>o for ER(CRAMM"NC an' t>o for R%US%& After a <rief
'iscussion/ the engineers clarifie' the 'iscrepancies an' agree' on the i'entical classification
metho'ologies& The t>o engineers then co'e' the remaining contracts&
Ta<le 5 contains 'escriptive statistics for all varia<les& Correlations are generally lo> to
mo'erate/ >hich suggests that multicollinearity is not a pro<lem for this estimation&
2222222222222222222222222222222
"nsert Ta<le 5 a<out here
2222222222222222222222222222222
$stimation
As our 'epen'ent varia<le is e8it from a population/ in this case the population of
Compustar customers/ >e use a ha)ar' rate mo'el in our estimation& "n the ha)ar' function
frame>ork/ the 'ynamics of 'uration time can <e conveniently capture' <y the ha)ar' rate/ hi*t.
>hich is 'efine' as the customer iFs pro<a<ility of terminating the relationship 'uring a particular
interval/ given that the customer has continue' the relationship until time t3
4,
. 5 &&&*
t
tO until ip relationsh the continue' has customer the
given t. t *t/ interval time in the ip relationsh the s terminate i Pcustomer Er
$im . *
,

+
=
t
i
t h
The ha)ar' function can also <e 'efine' in terms of the cumulative function 7*t. an' the
pro<a<ility 'ensity function f*t.B
. 4 &&&*
. * 5
. *
. *
t F
t f
t h

=
Note that the ha)ar' is the con'itional likelihoo' that a customer >ill 'efect at time t/ given that
she has not 'efecte' in the 'uration interval *,/t.& Co8 *5094. propose the proportional ha)ar's
regression *henceforth/ EHR. techni@ue to estimate the ha)ar' mo'el&
+
The ha)ar' rate takes the
form
. + .&&&* 8 * . * . Q *
t ,
t h x t h
i
=
>here h,*t./ the <ase ha)ar' function/ represents the longitu'inal effect of time& *8t. represents
the effect of covariates an' changes h,*t. up or 'o>n proportionately to reflect the effect of
covariates& The Co8 proportional ha)ar' mo'el assumes that *8. is an e8ponential function of
the covariates/ i&e&/
. 6 .&&&* R e8p* . e8p* . *
5
x x x
p
j
j j
= =

=

an' the ha)ar' function is
>here S*5/ 5/T&& p. 'enotes the parameters associate' >ith the covariates& The a<ove mo'el is
terme' proportional ha)ar's regression *EHR.& Transformation of the pre'ictor varia<les to 5,,8
+
The use of the Co8 ha)ar' mo'el re@uires that the proportionality assumption hol' true/ >hich it 'oes for our 'ata&
. : .&&&* e8p* . * . Q *
5
,
=
=
p
j
j j i
x t h x t h
45
*e8p *A.25. helps us to interpret the coefficients associate' >ith the covariates& This represents
the percentage change in the ha)ar' rate for a unit change in the correspon'ing covariate/ 8A&
Co8 *5094. presente' the semi2parametric partial likelihoo' function that is in'epen'ent
of the <aseline ha)ar' function to estimate the parameters& Suppose that a customer i terminate'
the relationship at time t& Hence/ the customerFs uncensore' 'uration time is t& At this 'uration
time/ t/ a num<er of other customers >ere Mat riskN i&e& the other customers that ha' not
terminate' the relationship >ith the supplier& These customers <elong to the Mrisk setN& (f all
those customers at risk *of terminating the relationship. at time t/ it is the customer i >ho actually
terminate' the relationship& Thus/ if a customer i 'efecte' at time t/ the partial likelihoo'
function that the customer i 'efecte' is
. - &&&*
. *
. &&& / / Q *
. *
5
. *
. * 4 5
t h
h
j j j t i L
t n
k
j
t i
t n
k

=
=
/
>here n*t. is the num<er of customers at risk at t/ an' these customers are 'enote' A5T An*t.&
Su<stituting the proportional ha)ar' mo'el/ the longitu'inal effect of h,*t. cancels out leaving
. 9 &&&*
. *
5
R
R
.
. *
&&&
4
/
5
/ Q *

=
=
t n
k
x
e
it
x
e
t n
j j j t i L
t j
k

Ma8imi)ing the a<ove likelihoo' yiel's the partial estimate of & East >ork has sho>n that
ma8imi)ing the a<ove likelihoo' gives efficient *%fron 5099. an' consistent *Tsiatis 5015.
estimates of &
Note that EHR mo'els the likelihoo' that a customer terminates the relationship given
that the customer has not yet terminate'& As a result/ the signs of the ha)ar' mo'el coefficients
44
>ill <e the opposite to the signs of 'uration mo'el coefficients& "n other >or's/ if U,/ then it
increases the ha)ar' an' thus the likelihoo' of a customer 'efecting&
Results
=e <egin >ith Mo'el 5/ >hich inclu'es only our control varia<les in Ta<le 4& The
control varia<les yiel' some interesting insights& BR%ADTH is negative an' significant *p V
,&,,5./ >hich in'icates that the more pro'uct lines the customer <uys from Compustar/ the less
likely the customer is to terminate the relationship *i&e&/ customer retention increases.&
"nterestingly/ neither measure of CompustarFs technical capa<ilities has a significant impact on
customer retentionB nor 'oes customer retention vary <ase' on >hether the proAect >as critical
for the customer& CompustarFs overall e8perience in the "T services in'ustry/ T"M%TR%ND/ has
a negative an' significant *p V ,&,,5. relationship on the likelihoo' of termination&
2222222222222222222222222222222
"nsert Ta<le 4 a<out here
2222222222222222222222222222222
Mo'el 4 in Ta<le 4 a''s our hypothesi)e' varia<les to Mo'el 5& The likelihoo'
improvement <et>een the tra'itional mo'el an' the propose' mo'el is statistically significant at
the 5G level& The log likelihoo' for Mo'els 5 an' 4 are 25+69&1 an' 25++4&59 respectively& The
=al' test reAects Mo'el 5 in favor of Mo'el 4 *the calculate'
4
S +5&4- >hile the critical
4
*54/
,&,5. S 4-&44.& There are no significant changes to the control varia<les in Mo'el 4& There is
some support for Hypothesis 5 as proAects >here it is 'ifficult to 'etermine @uality *CURR%NT
M%ASUR%M%NT C(ST. increase the pro<a<ility of customer termination *i&e&/ 'ecreases
customer retention. *p V ,&5,.& Erior proAects >here it >as har' to 'etermine @uality of the
pro'uct provi'e' <y Compustar also 'ecrease customer retention *p V ,&,5./ provi'ing strong
support for Hypothesis 4& No support is foun' for Hypothesis +/ as governance misalignment
4+
*CURR%NT CR"T"CA$ SUBC(NTRACT. has no significant effect& Hypothesis 6/ ho>ever
receives strong support as the cumulative num<er of prior misalignments 'oes re'uce the
likelihoo' of termination *p V ,&,5.&
Both kno>le'ge2<ase' hypotheses *Hypotheses : an' -. are supporte' as <oth current
proAects that create reusa<le kno>le'ge *p V ,&,5. an' the cumulative prior num<er of such
proAects *p V ,&,:. re'uce the likelihoo' of customer termination& 7inally/ >e fin' that the
num<er of prior proAects <et>een Compustar an' the customer significantly *p V ,&,5. re'uces
the likelihoo' of termination/ provi'ing strong support for Hypothesis 9&
=hile the results >ere supportive of Hypothesis 9/ >e >ante' to con'uct a''itional
analysis to verify ho> a prior relationship influences customer retention& Mo'el 4 uses a linear
measure of prior relationship/ <ut >e thought that there might <e a non2linear relationship
<et>een prior ties an' customer retention an' >e inclu'e' *ER"(R "T ER(!%CTS.
4
in Mo'el +
to test for such a non2linear relationship& The log likelihoo' for Mo'els 4 an' + are 25++4&59 an'
25+49&41 respectively& Again/ the likelihoo' improvement <et>een Mo'el 4 an' Mo'el + is
statistically significant at the 5G level& The =al' test reAects Mo'el 4 in favor of Mo'el + *the
calculate'
4
S +5&4- >hile the critical
4
*54/ ,&,5. S 4-&44.&
The s@uare' num<er of prior ties is negative an' significant *p V ,&,5./ >hich provi'es
support for the i'ea that customer retention increases as a relationship 'evelops/ an' 'oes so at
an increasing rate& The only other significant change <et>een Mo'el 4 an' Mo'el + is that
CURR%NT M%ASUR%M%NT C(ST is no> significant at the ,&,: level *rather than the ,&5,
level in Mo'el 4./ >hich provi'es stronger support for Hypothesis 5&
Robustness Tests
46
"n or'er to test for the presence of multicollinearity an' ro<ustness of the results/ >e
con'ucte' various tests& (ne such test is the variance inflating factor *?"7. test& "n general/ ?"7
value of less than 5, >oul' in'icate that there is no pro<lem of multicollinearity& "n our conte8t/
the ?"7 factor >as less than + >hich clearly in'icates that there is no pro<lem of
multicollinearity in our 'ataset& =e also con'ucte' the tests <ase' on eigen values an' con'ition2
in'e8 >hich also in'icate that multicollinearity is not a pro<lem in this estimation&
7inally/ >e ran the analysis >ith a variety of 'ifferent >ays of 'etermining >hether the
last proAect <et>een Compustar an' each customer in the sample represente' a terminate'
relationship or a right censore' event& =e use' the follo>ing alternative measures to co'e
termination3 *5. t>o stan'ar' 'eviations a<ove the entire sample average rather than the
customer specific average time <et>een proAects an' *4. fi8e' perio's of 54 an' 51 months& The
results are very similar across all four mo'el specifications&
"#SCSS#O!
The results offer some interesting insights an' theoretical implications& T>o theories that
shoul' influence customer retention are transaction cost economics *TC%. an' the kno>le'ge2
<ase' vie> *B?.& The results offer interesting implications for TC%& =illiamson *501:/ 5000.
states that the governance of a transaction nee's to match the characteristics of the transaction&
Specifically/ transactions su<Aect to contractual ha)ar's arising from asset specificity/
measurement costs/ inter'epen'ence/ etc&/ shoul' <e internali)e'/ >hile transactions free from
such ha)ar's shoul' <e outsource'& "n terms of customer retention/ TC% >oul' imply that
Mmisaligne'N transactions >oul' 'ecrease customer retention& (ur results she' light on this
theory in t>o >ays& 7irst/ >e fin' that it is cumulative misalignment/ rather than Aust
misalignment of the current transaction/ that influences customer retention& Specifically/ >e fin'
4:
that su<contracting a customerFs current proAect that is mission critical 'oes not impact customer
retention/ <ut a history of su<contracting such mission critical proAects for a customer 'oes
re'uce customer retention& This result is not inconsistent >ith TC%/ <ut it represents an area that
nee's further theoretical attention& =illiamson argues that misalignment >ill lea' to >orse
performance/ <ut >hen 'oes misalignment of the current transaction matter more an' >hen 'oes
history of misalignment pose a cumulative pro<lemW "n particular/ >hen might customers
'isplay for<earance for a one2time mistake <ut punish a consistent pattern of such misalignment
mistakesW This highlights the importance of firms learning from their governance mistakes/ in
line >ith =illiamsonFs *5000. call for more attention to learning in TC% research&
Secon'/ >e fin' that proAects that are su<Aect to high measurement costs 'ecrease
retention& This fin'ing also she's light on TC%& 7or instance/ the TC% literature suggests that
>hen there is greater 'ifficulty in evaluating performance/ the firms *customers. coul' integrate
<ack>ar' to their supplier*s.& Ho>ever/ in many instances/ such as in this in'ustry/ <ack>ar'
integration is not feasi<le 'ue to lack of resources an'Kor e8pertise& (ur fin'ings suggest that in
these settings/ customers reveal their preference for re'uce' am<iguity <y not rene>ing their
relations >ith this specific supplier an' e8ploring other suppliers& This outcome is consistent
>ith TC% literatureJperformance am<iguity poses pro<lems for market transactions&
The B? also offers potential 'eterminants of customer retention& The first is the tacit
kno>2ho> that firms 'evelop through their e8perience in the market an' >ith in'ivi'ual
customers& This accumulation of market an' customer specific tacit kno>2ho> ena<les them to
<etter serve their customers an' enhance retention/ in sum enhance their capa<ilities in customer
retention& =e fin' strong evi'ence of this as Compustar gets <etter at customer retention over
the sample perio'& This is a particularly interesting 'ata set for looking at the effect as >e have
4-
'ata 'ating <ack to CompustarFs entry into the "T services in'ustry& %ven controlling for repeat
customers/ <y e8amining the num<er of prior "T proAects >ith the customer/ there is still a strong
increase in CompustarFs a<ility to retain customers over the sample perio'& This supports recent
research into the importance of capa<ilities in areas such as managing alliances *e&g&/ ale/ Dyer
D Singh/ 4,,4. an' governance *e&g&/ Mayer D Argyres/ 4,,6.& =hile customer retention is a
'ifferent capa<ility than kno>ing ho> to effectively colla<orate *Do)/ 500-./ the t>o are relate'&
A strong colla<orative capa<ility shoul' help lea' to greater retention& !ust as colla<orative
capa<ilities 'evelop as firms learn to >ork >ith other firms/ customer retention capa<ilities
shoul' also 'evelop over time as the firm has more e8perience 'ealing >ith managing customer
relationships& Managing customer relationships is a <it 'ifferent than managing an in'ivi'ual
colla<oration/ <ut <oth shoul' 'evelop in the same >ayJthrough e8perience&
Another interesting aspect of the results is that learning <enefits are not Aust relate' to
overall e8perience in the in'ustryJcustomer2specific learning matters& Customer termination is
more likely as the relationship is 'eveloping an' is less likely as Compustar 'oes more proAects
for the customer& This outcome is consistent >ith t>o theoretical motivations& 7irst/ it coul' <e
that relationships lea' to either termination or trust/ an' once trust is esta<lishe' it helps the
parties ri'e out the <umps in the roa' an' continue the relationship *Culati/ 500:B Ring an' ?an
'e ?en/ 5006.& Alternatively/ this result is also consistent >ith a learning an' governance
e8planation& The longer Compustar >orks >ith each customer/ the more they learn to >ork
together an' are likely to 'evelop customer2specific routines *e&g&/ kno>ing >hat to put in the
contract/ kno>ing >ho an' ho> to ask for changes. to make their interaction more efficient
*Mayer D Argyres/ 4,,6.& These customi)e' routines represent a specific investment that >oul'
<e lost if the relationship >ere terminate'/ so the parties >ill re@uire a larger 'istur<ance in or'er
49
to resort to termination& Customer2specific learning can represent a specific investment that
influences customer retention&
=hile learning an' governance play important roles in customer retention/ so 'o
kno>le'ge consi'erations& =hile customer2specific e8perience resulte' in increase' retention/
>e also foun' that proAects >here Compustar create' kno>le'ge that it coul' reuse also
increase' customer retention& =e attri<ute part of this to an incentive effectB >hen Compustar is
<eing pai' to create kno>le'ge it can reuse/ then Compustar has a strong incentive to perform
>ell <ecause they are 'eveloping kno>le'ge that >ill make them more competitive in the future
<y a''ing to their stock of kno>le'ge& "n a''ition/ >e fin' a cumulative effect as the more
proAects >ith the potential to create reusa<le kno>le'ge that Compustar 'oes >ith a particular
customer lea' to increase' customer retention& This result is consistent >ith an economic story
that increase' retention is a result of a supplier >ith strong incentives to perform >ell& "t also
consistent/ ho>ever/ >ith a more kno>le'ge2<ase' learning story& !ust as Compustar learns ho>
to >ork more effectively >ith each customer/ Compustar also learns ho> to <etter incorporate
reusa<le kno>le'ge to serve the customer in the future& =hile the kno>le'ge has the potential to
<e reusa<le for other customers/ it is certainly reusa<le for future proAects >ith the same
customer& Thus Compustar appears to <e 'eveloping a capa<ility in harnessing an' re'eploying
kno>le'ge the more they interact >ith each customer& This e8planation is consistent >ith the
fact that our sample 'ates <ack to the <eginning of CompustarFs participation in the "T services
in'ustry an' the fact that learning >as a focus of their efforts over this perio' as they sought to
gro> the <usiness an' improve their performance&
=hile kno>le'ge playe' an important role in customer retention <y helping Compustar
perform <etter in future proAects >ith that customer/ so 'i' another factorJthe <rea'th of
41
CompustarFs e8perience >ith that customer& The more pro'uct lines that the customer procure'
from Compustar/ outsi'e of "T services/ the greater CompustarFs a<ility to retain the customer in
its "T services 'ivision& There are t>o possi<le reasons for this& 7irst/ customers <uy a greater
variety of goo's an' services >hen they are happy >ith a supplierFs performance/ so the effect
coul' simply <e that Compustar has <uilt up goo'>ill >ith these loyal customers that has le' to
increase' retention& Secon'/ the a<ility of firms to sustain their a'vantage in customer retention
'epen's on ho> goo' they are in leveraging their kno>2ho> an' learning across proAects an'
ho> goo' they are at leveraging an'Kor learning from their other e8periences >ith their
customers& 7irms vary in their a<ility to utili)e customer kno>2ho> across 'ifferent
pro'uctsKservice lines/ as they are <ought from 'ifferent 'ivisionsB hence capturing this customer
kno>2ho> across 'ivisions <ecomes important as it ena<les suppliers like Compustar to offer
more targete' services that are <etter suite' to the customer&
The kno>le'ge <ase' vie> *B?. >oul' also suggest that a strong technical capa<ility
shoul' also influence customer retention through higher customer satisfaction& "nterestingly/ >e
fin' that strong technological capa<ilities have no impact on customer retention& There coul' <e
multiple reasons for this& 7irst/ our measures of strong an' >eak capa<ilities coul' <e fla>e'&
=e <elieve that this is unlikely <ecause of the consistency of responses >e receive'/ <oth from
>ithin Compustar an' from others in the in'ustry/ regar'ing CompustarFs capa<ilities >orking
>ith mainframes an' their fle'gling capa<ilities in programming& Secon'/ it coul' <e that firms
may <e >illing to pay more to access a supplierFs superior capa<ilities an' thus e8pect more
from the supplier in such situations& Alternatively/ >hen a firm engages a supplier >ith >eaker
capa<ilities/ lo>er e8pectations that are more likely to <e met may <e involve'& Eerceptions of
the supplierFs performance may thus <e mo'erate' <y the customerFs e8 ante perception of the
40
supplierFs capa<ilitiesJi&e&/ customers may <e more sensitive to performance relative to
e8pectations than to a<solute performance& "t coul' also <e the case that these technical
capa<ilities in themselves are not a source of competitive a'vantage& =e are ho>ever/ not a<le to
'isentangle these issues in this current research&
Limitations- .uture Research- and Conclusion
(ne of the strengths of this stu'y/ the microanalytic 'ata from >ithin a single firm/ is also
a limitation& (ur 'etaile' an' panel/ transaction2level 'ata ena<les us to offer insights on ho>
<uyer2supplier transaction characteristics over time impact customer retention/ an issue that is
har' to stu'y across firms an' in'ustries given lack of panel 'ata availa<ility& Civen that the
maAority of the Compustar customers are large companies that have many alternatives >hen
selecting "T service suppliers >e are confi'ent that the negotiate' contract 'oes not solely reflect
Compustar policy <ut also significantly integrates specific customer concerns& The fin'ings from
this stu'y are likely to generali)e to other B4B settings as kno>le'ge/ learning an' governance
consi'erations are important in virtually all B4B settings an' are not limite' to the "T services
in'ustries& 7or e8ample/ e8changes in many high technology in'ustries *e&g&/ aerospace/
telecommunications/ soft>are/ pharmaceuticals an' semicon'uctors. involve firms >ith 'iverse
kno>le'ge un'ertaking a series of comple8 proAects that leverage firm2specific intellectual
property& 7uture research to confirm or 'iscount the generali)a<iliy of our fin'ings >oul' <e
valua<le&
=hile this stu'y takes an important first step/ a''itional research is also nee'e' to more
fully unpack the comple8 'eterminants of customer retention in B4B settings& There has <een
little analysis of customer retention in strategy/ even though that is an important varia<le >hen
stu'ying customer2supplier relationships& =e <elieve that more stu'ies of inter2firm
+,
relationships shoul' incorporate a measure of performance an' one such measure that 'oes not
re@uire 'etaile' financial 'ata is customer retention& =hile this measure is not perfect/ no
measure is/ >e <elieve that it is highly correlate' >ith customer satisfaction/ >hich >oul' <e
valua<le to incorporate into more stu'ies of customer2supplier relationships& As long as there are
other suppliers availa<le/ >hich is the case in most in'ustries/ customers shoul' only return if
they are satisfie' >ith the supplierFs performance&
"n a''ition/ >e <elieve that more research is also necessary to un'erstan' the cumulative
effects of prior interaction& %8change 'oes take place >ithin a comple8 >e< of past/ present an'
anticipate' future e8changes *Cranovetter/ 501:./ an' >e nee' to account for the past in or'er to
un'erstan' >hat is happening >ith the current e8change& Erior interactions can result in trust
*Culati/ 500:./ learning *Mayer D Argyres/ 4,,6./ relationship2specific investment *=illiamson/
5005. an'Kor other effects that nee' to <e e8plore'& 7ailure to account for ho> the parties
reache' the current e8change may result in missing important effects an' in misattri<uting a
knee2Aerk reaction to a current pro<lem >hen >hat is really happening is that the customer is
respon'ing to a series of pro<lems that have <uilt up over time&
+5
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+:
Table 0: "escriptive Statistics

?aria<le
Mean
Std
Dev Max Min 1 2 3 4 5 6 7 8 9 10 11 12
1 T"M%TR%ND 8.14 2.88 12 0 1.00
2
ER"(R "T
ER(!%CTS 4.12 7.44 41 0 0.26 1.00
3
CURR%NT
M%ASUR%M%NT
C(ST 0.44 0.50 1 0
-
0.13
-
0.10 1.00
4
ER"(R
M%ASUR%M%NT
C(ST 1.00 1.66 11 0 0.23 0.60 0.11 1.00
5
CURR%NT
R%US% 0.39 0.49 1 0
-
0.04
-
0.07 0.38 0.08 1.00
6 ER"(R R%US% 1.04 1.72 9 0 0.24 0.74

0.04 0.82* 0.09 1.00

7
CURR%NT
CR"T"CA$
SUBC(NTRACT 0.07 0.25 1 0
-
0.03
-
0.06
-
0.18 0.01 0.00 -0.01 1.00
8
ER"(R
CR"T"CA$
SUBC(NTRACT 0.15 0.39 2 0 0.20 0.43
-
0.06 0.28 0.10 0.53
-
0.03 1.00
9 BR%ADTH 4.25 2.77 9 0 0.13 0.55
-
0.21 0.21
-
0.05 0.30 0.02 0.32 1.00
10
CURR%NT
MA"N7RAM% 0.26 0.44 1 0 0.02
-
0.07 0.06 -0.02 0.05 0.00 0.10
-
0.02
-
0.07 1.00
11
CURR%NT
ER(CRAMM"NC 0.46 0.50 1 0 0.02
-
0.06 0.27 0.17 0.24 0.09 0.02
-
0.07
-
0.09 0.07 1.00
12
CURR%NT
CR"T"CA$ 0.47 0.50 1 0 0.23
-
0.06
-
0.05 0.02 0.10 0.04 0.29 0.09 0.01 0.28 0.08 1.00
X
Because of the relatively high correlation/ >e ran severeal tests *inclu'ing ?ariance "nfaltion 7actor *?"7. test. in or'er to test for multicollinearity& ?"7 >as less
than +/ >hich in'icate that there is no pro<lem of multicollinearity&
+-
Ta<le 4
Regression Results
Depen'ent ?aria<le3 T%RM"NAT"(N
Model 1 Model 2 Model 3
Breadth -0.171 *** -0.117 *** -0.142 ***
(0.024 (0.031 (0.032
!i"e !rend -0.176 *** -0.179 *** -0.195 ***
(0.025 (0.026 (0.027
#$rrent %ro&ra""in& 0.001 0.067 0.029
(0.121 (0.131 (0.131
#$rrent Main'ra"e -0.044 -0.025 -0.037
(0.145 (0.147 (0.146
#$rrent #riti(al -0.015 -0.025 0.002
(0.131 (0.138 (0.138
#$rrent Mea)$re"ent #o)t 0.244 * 0.330 *
(0.145 (0.148
#$rrent +e$)e -0.388 ** -0.390
(0.148 (0.147
#$rrent #riti(al S$,(ontra(t -0.002 0.033
(0.274 (0.275
%rior Mea)$re"ent #o)t 0.216 ** 0.183 **
(0.071 (0.069
%rior +e$)e -0.201 * -0.177 *
(0.091 (0.087
%rior #riti(al S$,(ontra(t 0.606 ** 0.658 ***
(0.202 (0.194
%rior -! %ro.e(t) -0.041 ** 0.039
(0.016 (0.030
(%rior -! %ro.e(t)
2
-0.002 **
(0.001

/o&-li0elihood

25+69&1 25++4&59 25+49&41

Y p V &5, Z p V &,: ZZ p V ,&,5 ZZZ p V &,,5
As this is a ha)ar' rate mo'el e8amining termination/ a positive coefficient signifies a 'ecrease
in customer retention *i&e&/ increase in the likelihoo' of e8it.&
X
=al' test reAects Mo'el 5 in favor of Mo'el 4/ an' reAects Mo'el 4 in favor of Mo'el +&
+9