The Customer Trap: An Interview with Andrew Thomas

We spoke with Andrew Thomas, PhD, associate professor of marketing and international business at the University of Akron, about his new book “The Customer Trap: How to avoid the biggest mistake in business.”.

How’d you become interested in this topic?

Having worked for years in sales and distribution logistics, I saw how much control was in the hands of the customer rather than the innovator. When I transitioned into academics, I looked into material on this issue, and I found that aside for some conversation from economists, there’s nothing being said on this from the strategic side of this. When I met Tim Wilkinson, my co-author, we kept looking for other folks writing and talking about this from a business school perspective, and we found nothing about this from any angle. I hope this engages the business community and helps people understand the implications of these kinds of arrangements.

Define A Mega-Customer.

A mega-customer is anybody that accounts for more than 10% of your company’s total amount of sales. Why 10%? First, 10% is a pretty large amount, so it’s intuitive. But a more substantive reason for this comes from managerial accounting, which requires that companies disclose any customers that account for more than 10% of revenue. This disclosure makes investors aware that there is a potential risk involved with such a customer.

What is the Customer Trap? How are Mega-Customers inclined to behave towards their suppliers?

The fundamental reality of the Customer Trap is that it’s the wholesale takeover of an innovator’s business by a Mega-customer. Because the supplier has an outsized dependence on that Mega customer for sales, the Mega customer will exert it’s power to continually extract concessions from its supplier.

A few examples: Mega’s will extract payment terms that are favorable to the Mega but not the supplier: “we’re more important to you now, so we’ll pay you when we want.” And then it’s requiring the supplier to buy, learn and use completely new IT systems. Mega’s will start charging suppliers for every little thing. They’ll receive access to the innovator’s formulas and trade secrets under the guise of “quality assurance” which may lead the Mega creating a cheaper knock-off version marketed and sold under their own brand umbrella. And they’ll hold hostage vital information about how your product or service takes its path to market.

Then the most obvious implication is pricing. If a mega becomes 10, 20, or 50% of your business, they realize they can influence pricing, so they’re going to ask you for discounts and deals and incentives that will ultimately lead to constant downward price pressure. When you’re under pressure to reduce price, the first thing to give is quality, and when quality goes, so does the cachet involved with the brand. Then, the product gets crowded with deals and offers which further tarnishes the brand to the point where it becomes a commodity. Plus, as your business becomes concentrated with a select few customers, your other clients will begin seeking more beneficial relationships with your competitors, causing your market share to become increasingly concentrated and at risk.

Of course, the ultimate consequence is clear: if you’re overly dependent on one or two Mega customers, their ending the relationship could be catastrophic for your business. On the other hand, if you have an expansive business, you’re more able to absorb the loss of a handful of customers, which is a requisite for survival in a hyper competitive global economy.

In the book, you mentioned a number of high profile companies who found themselves in the Customer Trap, including Jones Soda, Oreck, Levi’s, Goodyear, the Big 3 Auto-makers, Rubbermaid, Little Tikes, the list goes on. How’d they wind up there?

At the core of the proposition that Megas offer is the promise of incredible wealth. So these great companies enter a relationship with a Mega-customer and find out nothing could be further from the truth. Why do they do this? It’s a combination of a number of things. Part of it is complacency: companies feel that everything is fine today even if customers are becoming mega customers, and as a result they don’t really need to worry about it. Lack of discipline is part of it. Many of the companies we mention in the book who have avoided the Customer Trap have done so by being very proactive and deliberate about not letting their biggest customers become more than 10% of their business. For example, Oreck was disciplined about avoiding this for so many years under David Oreck’s leadership. But when he sold the company, their new private equity owners began selling through Target practically overnight. Their products became a commodity and they filed for bankruptcy soon thereafter.

Part of it is also short-term thinking driven by greed or management bonuses or any of the other factors that prioritize short-term thinking over what’s best in the long term. Executives know that if they cut a deal with a Mega now, their short term profits will be huge. The issue is that it’s great while it works, but then when it goes south as the Mega begins to assert control, it can ruin an enterprise more so than anyone else. Some companies never recover.

Are there any companies who have avoided Mega-Customers and the Customer Trap?

STIHL is a great example. The temptation for STIHL to sell their products in Home Depot or Lowes is so great, but throughout their history they’ve simply refused to do this. They believe that their brand, their products and their service are best in their own hands and in the hands of their own vetted dealer network. In fact, they ran a famous ad campaign in the late 2000’s explicitly stating their determination to never sell STIHL through big box or discount dealers.

Of course, STIHL realizes that if they did pen a deal with a Mega, they would have 1 or 2 years of incredible growth and record profits unlike anything they had ever seen. But then after that, once the control is firmly in the hands of the new Mega customers, the trap would set in and all that STIHL has built over 90 years would be ruined. And even a company like STIHL can’t prevent themselves from falling into the trap. A Mega is not reliant on one supplier- they have thousands of suppliers- so they can set any one loose at anytime and have it have a negligible effect of their bottom line.

Explain how you believe the Customer Trap contributes to offshoring and the erosion of America’s industrial economy.

In 2003-04, when offshoring was really accelerating, a lot of people were talking about the greed that was driving this. And perhaps that was true to an extent, but you have to look at the pressures companies were beginning to feel from their Mega customers and the pressure those customers were exerting. Mega’s call up and say “because I’m 40% of your business, I‘m going to mandate 10% price reductions across the board every year.” So if a company is being required to deliver those price reductions because of this dysfunctional relationship they have with their Mega customer, the only way that company will be able to continue to make money dealing with these customers is by cutting costs. And one big way to do this is offshoring.

So what should companies do instead?

The reality is that Walmart doesn’t go out to people and ask them for their product. The innovators are the ones coming to them. So what really needs to take place is a conversation at that decision point: what are going to be our distribution channels, and who is this product for? Is this product for Walmart, or is it for our customers? And if it is for Walmart, you have to recognize the implication of that.