Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
  • How do you encourage speedier adoption of your product or service?
  • How do you increase the value your product or service creates for your customers?
  • How do you extract more of the value created by your product or service for yourself?


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The US is a services-based economy, and US consumers demand good customer service. Customers have increasingly been using social media to publicize incidences of bad customer service, and many customers use online reviews to determine which businesses to patronize. All of this suggests that companies providing bad customer service should be forced either to improve or to go out of business. Yet, in many cases, lousy customer service has been able to persist without causing businesses significant financial harm. How can this be?

You see this situation, for example, in cases of:

  • Airplane flight delays or cancellations or lost luggage;
  • Utility service continuity or billing problems;
  • Retailer exchanges or returns; and
  • Food Services ordering problems or problems with quality of food or service.

This analysis examines the Customer Service Game and seeks to understand how businesses can continue to profit despite having chronic customer service problems.

Overview of the Game

There are three groups of players in the Customer Service Game:

  • Companies that provide services to customers,
  • Agents of the company who interact directly with the company’s customers, and
  • Customers of the company

Customers must decide whether or not to purchase a product or service from the Company, given

  • The Company’s product and service offerings;
  • The Company’s reputation;
  • The Customer’s stock of loyalty with the Company; and
  • Available alternatives to the Company’s products and services.

Customers who decide to purchase from the Company and who experience a problem with the Company’s product or service contact an Agent of the Company to resolve the problem.

The Agent can provide either good customer service or bad customer service.

If the Agent provides good customer service then Customers continue to buy products and services from the Company, and the Company’s reputation improves.

If the Agent provides bad customer service, then Customers may stop buying products and services from the Company, the Company’s reputation declines, and the Agent may be fired.

Game Players

The players in the Customer Service Game, together with their incentives are displayed in Figure 1 and described in more detail below.

Figure 1

customer service game


Customers choose to buy those services that maximize utility. Customer utility is higher when 

  • Prices are lower;
  • Convenience is higher, where convenience in the airline industry includes frequency of fights, need to make connections, etc.;
  • Customer Service is higher, where customer service includes the ability to make changes in travel plans and the ease of rescheduling flights during delays and cancellation; and
  • Loyalty is greater, where loyalty is the extent of use of and/or stock of credits in loyalty programs, such as frequent flyer programs, sponsored credit cards, points programs, etc.


Agents provide a level of service to customers, given the level of wages and amount of training provided by Companies. The level of service provided by Agents is higher when

  • Wages are higher; and
  • Knowledge is higher, where knowledge of how to solve Customers’ problems is higher when Agents have

º  Greater training and

º  Greater time on the job (i.e., low turnover).

Low wages lead to bad customer service, both directly, by decreasing Agent morale, as well as indirectly, through increasing Agent turnover, which contributes to lack of Agent knowledge, and thus the provision of bad customer service.

Low Agent training also leads directly to bad customer service, because untrained Agents don’t have the proper knowledge needed to resolve Customers’ problems.  


Companies are profit maximizers. They choose prices to charge Customers, wages to pay Agents, amount of training to provide Agents, and services to offer in Loyalty Programs to maximize profits from sales of services to Customers.

Loyalty programs entail costs of administration, but they benefit Companies by generating greater Customer loyalty. Good/Effective loyalty programs can increase the Company’s profits by returning greater loyalty than the costs of generating that loyalty. However, poor/ineffective loyalty programs can decrease the Company’s profits by returning less loyalty than the costs of generating that loyalty.

Customer Service Issues

Company Segmentation of Market Demand

Some Customers are high value Customers for Companies, while other Customers are low value.

  • Low Value Customers value low prices more than they value convenience and service. Furthermore, Low Value Customers are not loyal to particular companies, but rather, they purchase products and services from the Companies that currently offer the lowest prices.
  • High Value Customers, on the other hand, value convenience and service more than low prices. Additionally, High Value Customers are likely to be loyal (i.e., provide repeat business) to Companies that provide them with high levels of convenience and service.

Companies have been able to segment their Customers by offering two different sets of products and services

  • Low price and low service, and
  • High price and high service

and then letting the Customers identify themselves as either Low Value or High Value Customers, depending upon which set of products and services they choose.

Customers self-select into the low value group, for example, by buying nonrefundable economy class airline tickets, shopping at bargain retail stores, or dining in fast-food or other low-price restaurants. These Customers generally tolerate bad customer service when they have problems, because they value the low prices the Companies charge more than they dislike bad customer service.

Customers self select into the high value group, for example, by buying fully changeable and/or first-class airline tickets, shopping at high-end retail stores, or dining in expensive restaurants. When they have problems, these Customers generally benefit from good customer service, because they willingly pay for the good service through higher product and service prices.

Buy segmenting Customers into groups, Companies are able to minimize total expenses for the provision of customer service. Companies spend little on customer service for Customers who don’t value good customer service, while focusing their customer service efforts (expenditures) on those Customers who do value good customer service.

Customer Loyalty Programs

Customer loyalty programs have evolved over time. In the “old days” (i.e., pre-digitization), Companies would offer Customers rewards for making repeat purchases. Each time Customers made a purchase, they would receive, for example, stamps, box tops, UPC labels or card punches. After they had acquired a certain number of stamps or punches, they would redeem them with the Company for free products or prizes.

More recent customer loyalty programs generally grant Customers price discounts on the Companies’ products and services in exchange for being able to track Customer purchase information. Some price discounts come in the form of immediate discounts on select items; grocery stores and pharmacies use these types of loyalty programs. Other price discounts come in the form of a free product or service after a certain level of purchases has been reached. These types of discounts include, for example, receiving a free airline ticket after having flown 25,000 miles on that airline.

Regardless of the type of loyalty program, the purpose of the program is to increase Customer loyalty to particular Companies’ products and services. As I mentioned above, Low Value Customers will tend to switch brands depending on which offers the lowest price. Loyalty programs are a way for Companies to increase the loyalty of Low Value Customers, even when the Company doesn’t necessarily have the lowest price. More specifically, when Customers are members of a Company’s loyalty programs, they will often choose the sponsoring Company’s products and services, even if they aren’t, in fact, the lowest priced offerings available. This increased loyalty is due, for example,

1.  To the expectation that the loyalty member’s discounted price will be lower than other Company’s non-member prices;

2.  To other benefits received from being a member of the loyalty club, such as early access to new products; or

3.  To earn more points towards receiving free products or prizes.

How Companies Get Away With Providing Bad Customer Service

Let’s now consider different types of companies that offer customer service and try to understand how they’re able to get away with providing bad customer service.


Airlines have notoriously bad customer service in the cases of flight delays or cancellations or lost luggage. Airlines are able to get away with bad service using a combination of methods:

  • Market Segmentation

Airlines segment customers into Low Value Customers and High value Customers based on the fares Customers choose.

Low Value Customers are provided with bad customer service because Airlines know that these Customers prefer lower prices (and convenience) to good service, and as long as the prices are low, Low Value Customers will continue to patronize them, despite being provided with bad service.

High Value Customers are provided with good customer service because they value good service and are willing to pay for it in the form of higher ticket prices.

  • Loyalty Programs

Airlines increase the loyalty of Low Value Customers by offering them memberships in loyalty programs. Low Value Customers are generally quick to switch carriers to get low fares. However, Low Value Customers who are members of particular carriers’ loyalty programs are less likely to switch carriers due to differences in ticket prices.

  • Monopoly Power/Convenience

Perhaps one of the biggest reasons that the major airlines have been able to survive in the industry despite providing bad customer service is that they hold monopoly power on many routes. For example

º  At SFO United and Delta together account for over half of all flights,

º  At ATL, Delta alone accounts for about three-quarters of all flights, and

º  At JFK, Delta and JetBlue together account for over half of all flights.

The largest carriers at hub airports have a lot of power over local customers by offering the most convenient – if not the only – flights to many locations. Customer can complain all they want, but in many cases the airlines providing bad service are the only carriers available to take them to where they want to go.


  • Monopoly Power/Convenience

Utility companies (electric companies, telephone companies, cable companies, Internet service providers, etc.) surely get away with bad customer service because there are only a couple of providers in many markets. Electric companies and local phone companies have historically been regulated monopolies. Despite the telephone market being opened up to competition from Internet service providers, many regions still suffer from effective monopoly or oligopoly markets. As such, customers are generally at the mercy of providers.

  • Bundled Services

As the larger utilities have penetrated multiple markets, they have also introduced bundled services (i.e., combined telephone, cable, and Internet services) as a means to increase customer loyalty. Providers sell customers on bundled service citing lower prices and better convenience for bundled services. However, bundled services may not, in fact, offer the lowest prices. For example, Martha C. White, in “No 'Bundle' of Joy: Cost of TV, Internet and Phone Service Rising,” reports that

And while many consumers assume that bundling TV, Internet and sometimes phone services means they are saving money, that might not be the case.

"While double play Internet and television packages have promotions for as low as $35 per month, and triple plays (adding phone service) as low as $45 per month, most subscribers are paying much more - the average for Internet and television is $132 per month, and the average spend on three services is $165 per month," market research firm Mintel said in a report earlier this year.

A separate 2013 Mintel survey found that triple play subscribers on average paid more than those who signed up with multiple providers, while double-play subscribers saved an average of $8 a month.

What is definitely true, however, is that customers who purchase bundled services are more loyal to providers, that is, they exhibit lower churn rates. More from Martha White:

William F. Osbourn, Jr., Time Warner's senior vice president, controller, chief accounting officer and acting co-CFO, told investors on the company's most recent quarterly conference call that triple-play customers contribute half of the company's residential recurring monthly revenue, and that they tend to jump ship, or "churn," less often.

Retailers and Food Service Providers

For the most part, retailers and food service providers have catered to segmented markets. Low price providers offer products at low prices, but often end up with bad customer service. Conversely, high price providers cater to customers who value service and accordingly provide good service with their higher-priced products and services.

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