[Editor's note: During the early days of the Pandemic, many companies did an excellent job of reducing expenses and conserving cash flow. However, we have observed in the last 12 months a disturbing trend. In the drive to improve the top line, companies are beginning to lose focus on the importance of "profitable growth." We decided to re-run a series on profitable customer growth. In Part 1 we outlined how a few customers can drive net profitability. This is Part 2 - a process to improve profitability. We hope you find it useful. -DPM]
Improving Your Business: One Profitable Customer at a Time
Part 2 - A process to improve profitability
Many managers seem to rely on intuition to determine if a customer is profitable or not. Sometimes the intuition is correct and sometimes it is not. Besides one's intuition not being correct, relying on intuition to determine customer profitability confuses the organization. Why? One's intuition varies greatly depending upon position in the organization and how the relationship is viewed. For example, for the sales vice president trying to make a sales goal, that unprofitable customer can be very attractive. For the technical director who must provide support to that same customer, the relationship appears very unappealing. There must be a process for assessing customer profitability and it needs to be used consistently throughout the organization. Here are some suggestions:
Define your core strengths
Customer profitability centers on what a company does well and then matches these strengths with a customer group which values them. BMW is known for its ability to design and produce high quality cars with great road handling characteristics. As an organization, it understands this strength and seeks to cater to customers who seek cars that have excellent handling characteristics.
Take a hard look at your organization. What does it do exceptionally well? What differentiates it in the market? Ask this question of people throughout the organization. The responses may differ based upon who you talk to but you should hear some consistency about the core strengths of the business. Expand your analysis beyond internal perceptions; ask your better customers why they buy from your company. This is the first step in identifying where your organization needs to focus its efforts.
Study and Determine the characteristics of profitable and unprofitable customers.
Take the top 10% - your most profitable customers. (Mead Consulting can help you with a process to identify these customers on a net profit basis).Do these customers have similar characteristics (e.g., technical requirements, order size, etc.)? What types of products and services do they purchase? Are these customers more profitable because they are more loyal (sales and marketing expenses are less)? How do the characteristics of this customer group align with your company's strengths? You will likely see an alignment if you look closely enough.
We have worked with a company in the software industry with a long history of profitable growth. Its projects are typically long-term in nature and management takes customer selection very seriously. The company's disciplined customization and project management process includes a great deal of client collaboration. At the heart of the process is developing a good understanding of project objectives and the customer's customer. Key to the company's long success has been selecting clients whose approach fits the process and are good candidates for repeat business. The company avoids single project clients shopping solely based on price, since this approach does not fit well with their collaborative process.
After you have looked at your top customer group, repeat the process with less profitable customers. What are the common characteristics of these customers? They are likely very different than those more profitable customers.
Establish guidelines for evaluating customers.
If you wish to move beyond simply talking about customer profitability, you must establish guidelines for evaluating customers. Guidelines could include:
- order size (orders in quantities the company is set up to handle)
- product mix (customer is not just cherry picking to get the lowest priced products or services. This is important if you offer loss leader products)
- technical support requirements (can the customer be effectively served?)
- growth potential (does this customer have the potential to grow?)
- how long will you let a customer receive special treatment (i.e., "freebies", special pricing or terms, etc.) on "potential" alone
As you can see from the above list, it is a combination of financial measures, buying practices and long-term potential. Do not worry about developing the "perfect" measure. The most important thing is to develop consistent parameters that make sense for your business. If you apply these criteria consistently, you will see a clear segmentation between your best and worst customer relationships.
Taking Action - One Customer at a Time. Focus Time on "high potentials"
Now that you have defined the profile and characteristics of profitable customer relationships, begin putting the evaluation process into action. One of the first places to start is with prospective customers. Focus your energies and sales efforts on prospects consistent with your evaluation criteria. Prospects that do not fit most of your evaluation criteria are not likely to develop into long-term profitable customers. Make sure your sales team has a clear understanding of the types of prospects you are targeting.
As you attempt to improve profitability, focus on your top quartile relationships as these customers often represent one of your best growth opportunities. Map out clear strategies for retaining and growing these relationships. Learn more about your customers' businesses and how they serve their customers. This collaboration can uncover new opportunities and help you forge stronger relationships. As you eliminate the unprofitable relationships, this frees up time and other resources for your more profitable customers. This is an important principle of executing a successful fewer and deeper strategy.
Don't fire unprofitable customers. Modify the unprofitable behavior.
What can you do about unprofitable relationships? Be aggressive about changing those unprofitable relationships. Make certain the sales team understands that the customer must become more profitable within a given time.
Don't just fire customers, however. Often, it is we, the sellers, who have encouraged or permitted "unprofitable behavior." These customers may offer profit potential - particularly if they fit many of your evaluation criteria. Look for differences in how you are serving these customers versus your more profitable segment. You may be overlooking product or service opportunities that could enhance profitability, or you may be making inaccurate assumptions about client needs. One client's management team believed it was obligated to supply certain customers with unprofitable commodity products in order to sell more profitable, high margin product lines. Our interviews with customers revealed otherwise. There were many alternatives for procuring commodity products and customers were primarily interested in the more innovative, higher value product lines. A subsequent change in product mix has boosted profitability significantly.
If a path to profitability cannot be found, use pricing as a way out of a relationship. Be sure to provide recommendations for alternative vendors. You never know when an unattractive customer can change and become desirable.
In current inflationary times, be creative to ensure profitability.
With rising input costs, maintaining profitability can be challenging. Some companies with significantly rising or uncertain component prices, have resorted to surcharges based on some index for those components. In that way, pricing changes are somewhat transparent and the customer can see that one day the prices may be adjusted downward.
If there is no clear path to profitability under your current product and services umbrella, consider offering alternative services
Many successful middle-market companies take pride in their premium, high touch service levels. Each customer usually receives the same products, services, and delivery regardless of profitability. This approach, combined with the size or buying practices of some customers, makes some relationships appear hopeless. If there is no clear path to profitability under your current product and services umbrella, consider offering alternative services for these customers. This may be a particularly viable alternative if you have a large segment of unprofitable customers with similar needs. Depending on your business, alternative services may entail different methods of selling (e.g. inside sales vs. more costly face-to-face), a different scope of service or different pricing structures. These changes can completely change the profitability picture for these customer relationships.
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The Mead Consulting Group has been helping clients identify and improve customer net profitability and execute strategies that drive profitable growth. For a free consultation, contact me at meaddp@meadconsultinggroup.com or (303)660-8135
The Mead Consulting Group has been helping clients develop and execute Strategic Growth & Execution plans for many years. Check out our website for descriptions of some client success stories.
Best regards,
Dave Mead
