There really needs to be a warning label on most “customer profitability” analytics articles. This stuff is can be more addictive than angry birds and often guides management teams into restructuring plans that destroy more value than they create.
On the surface it seems pretty intuitive. Calculate net revenue. Tally your costs. Allocate them to business activity at an agreed upon level – could be customer, transaction, or even line item. You now have the basis of a customer profitability report, a neat listing of what you supposedly earn from each of your accounts.
Typical Implementation – Unintended Consequences
Most good managers have a visceral reaction to unprofitable business. Fix it or Exit it, of course. There’s nothing to lose, right? If we’re getting paid only $5,000 and consuming $7,500 worth of product, we’re looking at an instant $2,500 profit if we send back the next purchase order.
If only it were that easy. Exiting unprofitable revenue is fairly easy: an awkward conversation or two, followed by a stop in orders. The costs, on the other hand, frequently don’t leave the organization at the same rate. Some of those allocations are more theoretical than they appear.
Productive sales activity generally falls to a grinding halt. Your seller is likely getting a commission on the account in question, so they are highly motivated to challenge the data and point out the risks of taking any action. This takes time away from useful activities like prospecting and account development. Front line sales managers, who spend far more time with their reps than their boss, will find themselves dealing with a string of aggravated reps pushing back on the program and will require reinforcement from their own management to hold the line.
Even worse, the advantage frequently lies with the challenger in most of these disputes. A high portion of the costs in the model will be allocated rather than directly charged to an activity. This gives a creative talker ample ways to cast doubt on the analysis. Even worse, people can start using “water cooler math” to create their own alternative views of cost from rumors, wage rates, and internet quotes. While they may sound reasonable to the viewer, these estimates rarely capture the fully loaded cost of managing the operation. Debunking this only serves to slow things down further.
And the forth horsemen of the customer profitability apocalypse…. perfectly natural random variation in customer orders over time. This problem shows up when you make the decision to “tighten things up” and “watch them more closely”. All of a sudden, you’re totally immersed in the minutiae of what was ordered when, which products were missing from an order, and why a handful of orders rolled to the following month and messed up the allocations. Because once you get down to a handful of orders, the customer starts dancing back and forth across the all-important “zero line” of profitability.
It’s time to take a step back and think about what we really want here: higher profits and a sales force free to focus on getting good business. Not this unscheduled master class in MBA accounting….
There are ways to use your customer profitability report to accomplish this; we just need to use some different tactics.
Customer Profitability Strategy #1 – The No-Fly Zone for Exceptions
I have yet to see a business that didn’t have a few ways to bend the rules for a favored customer.
Sure, we’ll waive the design charge. Or sell you a custom / special order item at the same price as our house brand. Need that tomorrow? No problem, we can pay the freight at our expense. Need us to re-format everything in your preferred template? No problem, we’ll have one of our staff handle it. That price increase? Sure, we can defer it for 60 days. Not a problem.
Well, that needs to stop for unprofitable customers. If we’re going to making exceptions anywhere, it shouldn’t be for these guys. Fees are charged per the standard agreement. Price increases will be implemented on time and in full. These are reasonable business asks and need to be honored.
At a minimum, it will recover a little bit of the net profit leakage. It may also embolden your team to claim similar charges at “profitable accounts”.
Customer Profitability Strategy #2 – Rebuild Share in the Account
Unprofitable relationships are rarely the result of your initial decisions on the account. When you first considered doing business with that account, they proposed a mix of products they would purchase and gave some indications of their expected volumes. Someone reviewed it and shook hands.
Since then, life has happened. Maybe their business shrunk. Maybe another vendor got in there and went after the better pieces of the assortment, leaving us with the dregs. Perhaps the sales representative and buyer positions have turned over. Perhaps the industry has experienced significant cost inflation, which has not been recovered by rigorously implementing price increases. In any event, the balance within the account has changed.
Many unprofitable accounts tend to have problems with the mix of products we are selling them. The price is competitive, sure, but there are often profitable customers paying similar prices. What’s missing is the rest of the product bundle, which brings order size to an acceptable level and will ensure you’re selling the high profit items as well as the loss leaders. The business is frequently there, we just need to pursue it.
So instead of showing up with a unexpected price increase, what if we just… sold them more stuff? Has anyone shown them some new products? When was the last time we took a run at the balance of their core assortment?
And if you’re really crazy (like me), you might even offer these items at a lower cost to make the customer feel good about the change. Or you can politely explain to the customer that we really need support on this additional business to maintain the great deal they receive on the other items.
See, that wasn’t so bad, was it?
Customer Profitability Strategy #3 – Push High Profit Products
A slight variation on the second strategy. There are certain items in our offering that will generate a higher profit for the account.
For wholesalers, this could include shifting convenience business and purchases for internal use to the distributor’s private label program. You may also be able to shift their branded purchases to items in our core assortment which are commonly purchased by other accounts. These products will generally have faster turns and better acquisition costs than non-core products, earning us higher margins on this volume across our total business.
For manufacturers and service companies, this could include products which we can make or deliver very efficiently. Perhaps we already have a big account buying a similar item, so we can run a few extra cases of that product at a low marginal cost. Or the process of fulfilling that service could be highly automated, allowing us to include that product in our offering at minimal cost.
Use your customer profitability analytics to identify your most profitable items and promote them broadly within your customer base.
Come to think about it, you should probably be selling this item to everyone….
Customer Profitability Strategy #4 – Service Consolidation
Potentially a little more risky, but consider asking the customer to consolidate their orders and schedule their business within specific windows.
Logistics and customer service is are areas where a little coordination can take out a lot of cost. Look into route schedules and deliver windows, working with your sales team to guide customers and orders onto the same truck for efficiency. On the selling side, look at options to decrease time spent visiting each account, either through route planning or judicious use of inside sales and phone calls.
Most buyers are willing to work with you if you’re going to protect their price, the most visible element of their performance to their bosses.
Customer Profitability Strategy #5 – Replicate Your Best Customers
There will most likely be an 80 /20 within your book of business when it comes to customer profitability. The best performing relationships are worthy of careful study to understand how we got there. Dig deep, visiting the customer if possible and getting the history behind the account. Develop a profile of the business, identifying the key factors which appear to be responsible for the above average performance.
Now… go find prospects which match that profile and bring more of them into your book of business. Assuming they are within reach, focus your business development resources on the prospects which most closely resemble the vital few customers that account for most of your profitability. Engage your product, marketing, and strategy teams to identify how you can enhance your value proposition for this particular audience.
While you need to be patient with this strategy, this can be the most rewarding part of your pricing journey. Your most profitable accounts are a powerful indicator of what customers truly value about your services, your rightful role in the marketplace. By focusing your business growth and product enhancements on this high potential audience, you’re playing to your strengths and stacking the deck for growth.