Hedging Customer Risk

Abstract

Companies and academics rarely account for balancing the risk and reward in a customer portfolio of a firm. Unlike a stock portfolio where both measures are taken into account, many people tend to look only at the customers’ average profit value. Applying financial portfolio management techniques to customer management has been an under-researched topic in academic marketing literature. In this paper, we propose a methodology that allows firms to create a customer portfolio maximizing return for a level of risk. We illustrate the potential benefits by optimally weighting the customer segments based on their risk–reward impact on the firm’s overall customer portfolio. Our method can be used to assist investors in their valuation of a firm or to value an acquisition with a primary goal of increasing the customer base. We use a dataset of 1,901 customers covering seven quarters for a total of 13,307 observations of a major US bank with a market capitalization exceeding $40 billion. We show measurable potential increase in profit by implementing customer portfolio management practices.