Are All of Your Customers Profitable for Your Business?
Every business needs customers to survive. Owners typically spend a lot of time and energy trying to attract customers to their businesses and then keep them. They rarely asking whether those customers are actually desirable ones. But if you want your company to truly thrive, you may need to evaluate whether your customers are raising your business — or dragging it down. It may make financial sense to drop those that fall into the latter group. Fulling Management & Accounting has found the book The Pumpkin Plan by Mike Michalowicz a wonderful resource on evaluating the value of your clients.
Track the Data
Determining individual customer profitability should be your first step when considering which (if any) customers to drop. If your business systems track individual customer purchases and your accounting system has good cost accounting or decision support capabilities, this process will be simple. If you have cost data for individual products, but not at the customer level, you can manually "marry" product-specific purchase history with the cost data to determine individual customer value.
Even if you don't maintain cost data, you can sort the good from the bad by reviewing customer purchase volume and average sale price. Often, such data can be supplemented by general knowledge of the relative profitability of different products. Be sure that sales are net of any returns.
Don't ignore indirect costs. High marketing, handling, service or billing costs for individual customers or segments of customers can significantly affect their profitability even if they purchase high-margin products. If you use activity-based costing, your company will already have this information allocated accurately.
If you don't track individual customers, you can still generalize this analysis to customer segments or products. For instance, if the same distributor serves one group of customers, you can estimate the resources used to support that channel and their associated costs. Or, you can have individual departments track employees' time by customer or product for a specific period.
Sort Your Customers
After you've assigned profitability levels to each customer or group of customers, sort them by that level. For example, the A group would consist of highly profitable customers whose business you'd like to expand. The B group would be made up of customers who aren't extremely profitable, but who still positively contribute to your bottom line.
Last, but not least, the C group would include those customers who are dragging down your profitability. These are the customers you can't afford to keep because, for example, they're overdemanding and abusive to employees, expect special servicing or constantly request more time to pay invoices. In other words, they're in the "no longer profitable" category.
Create Differing Objectives
With the A group customers, your objective should be to grow your business relationship, because they're worth going the extra mile for. Spend time learning why they're your best customers. Identify what motivates them to buy your product or service, so you can continue to meet their needs. For example: Is it your products? Your level of service? Some other factor? Developing a good understanding of this group will help you not only build your relationship with these critical customers, but also target marketing efforts to attract other, similar customers.
Your B group customers may be OK, but, just by virtue of sitting in the middle, they can slide either way. There's a good chance that, with the right mix of product and marketing resources, some of them can be turned into A group customers. Try to identify those who have a lot in common with your best customers. Then focus your marketing efforts on them and track the results.
When it comes to the C group, spend a nominal amount of time to see if any of them might move up the ladder — it could be possible if you give them a lot of attention. It's more likely, though, that your C group customers simply aren't a good fit for your company.
Fortunately, "firing" your least desirable customers probably won't require you to call them and tell them to get lost. Just don't focus on them. Stop spending money by sending them emails or mailings. Also, tell your salespeople to stop calling on them, and don't offer any additional discounts. After a while, most of these customers will leave on their own.
Prune for Growth
It may seem counterintuitive to intentionally let go of customers. But as with any shrub or tree, by pruning and getting rid of deadwood, you'll create space for a healthier company to grow. You'll also be better able to focus on — and serve — your best and most profitable customers, ensuring that they'll continue to stay loyal to your business over time. Fulling Management & Accounting has found the book The Pumpkin Plan by Mike Michalowicz a wonderful resource regarding pruning your clients.