Creating More Profits by Firing Your Customer
Our studies show that about 80% of a company’s current customer base generates about 130% of the current level of profitability. This finding means the remaining 20% cost more to maintain and service than the revenues they generate. The ability to identify which customers are truly profit-generators and which aren’t becomes a powerful management decision tool.
Customer Profitability Analysis
Some customers require more attention than others. Every sales professional can identify the high- and low-maintenance customers. The cost of customer support and retention can be driven by:
- Packaging requirements
- Engineering change orders
- Shipping and handling restrictions
- Inventory stocking levels
While the drive for excellence in customer service is always a paramount focus of every small- to medium-size business (SMB), understanding the costs incurred to service each customer versus the revenues generated by that customer is critically important.
Developing the Customer Profitability Analysis Model
The Customer Profitability Model consists of the following components:
- Recognition of revenues by customer
- Recognition of production costs by customer
- Recognition of the cost of activities triggered by the following drivers, by customer:
- Unique packaging and other minor production customization
- Unique billing/invoicing arrangements
- Unique production runs
- Warehousing of contingency stock
- Unique merchandising requirements
- Development of a customer-driven P&L statement.
Using activity-based cost accounting (ABC) to identify the costs of products delivered by department, such as IT, accounting, purchasing, and others, is the key element of the customer profitability analysis. ABC determines what unique requests are costing you at each stage of production and delivery to figure your true costs. By understanding these hidden costs in a customer’s unique requirements, you’ll make better decisions. So…are you ready to fire your marginal customers? You should be. Simply stated, marginal customers are costing you more than you realize. It’s easy for a struggling SMB owner to rationalize that accepting lower margins on some customers and making higher margins on others is OK, especially if your sales are down. But this thinking works only if you and your business have unlimited resources and unlimited time. More than likely, your cash reserves, credit line, production capacity, and your company’s ability to carry inventory and accounts receivable come with limits. Finally, you possess only 24 hours each day. Spending one of those hours dealing with a poor, demanding, slow-pay customer prevents you from effectively serving the good ones. The following is a sampling of some of the customer traits to look for in identifying “Hit List” customers and some ways to turn them into good customers…or fire them:
The 90-Day Customers
The Situation: You know the type. Their story is “I’m really having a tough time now. I’ll pay you next week.” This circumstance requires a series of phone calls and multiple invoices. In the mean time, you’re paying interest on your line of credit, and don’t have the cash to pay your employees and your bills. They always have a good story of doom and gloom, and they apologize for tardiness and promise that the “…the check is in the mail.” On the other hand, they blame YOU for faulty merchandise, poor service provided, late shipments, etc.
The Solution: Develop and communicate clear credit policies. Charge them interest on accounts open more than 30 days. Put them on a COD status and require payment of all open invoices before additional shipments are made. Don’t be fooled and re-extend terms after only one or two prompt payments. Wait a year or six months before revisiting the credit status of these customers.
The “I Can’t Decide” Customer
The Situation: You serve a customer who is constantly altering or continually expanding his or her needs, but won’t tolerate a change in your price. These customers are the type who shop at the “Price-Club” store but expect “Park Avenue” level service. Typically, they see needs as basic because they haven’t totally analyzed and communicated their real requirements. As you begin to provide the service, or build product, they redefine their requirements and don’t want to pay more than the original price.
The Solution: These customers simply don’t understand the impact their changes make on YOUR business. For existing contracts, before firing them, educate them. Explain the impact of their requested changes and tell them an additional charge will be added. Then, if they balk, “Down the road!”
The “Discount Coupon” or Incentive Customer
The Situation: You distributed a coupon to advertise and attract new business. The offer was a “Limited Time Only” or similar offer. Or you agreed to accept a lower fee for this contract only to help your client. Now these customers won’t accept the higher price and demand the lower cost indefinitely. The Solution: First determine the pricing and terms you’ll accept to keep the customer. Speak with the customer and specify the standard prices and when the discount period ended. Explain why you need to bill at the standard rate. Don’t waver. Be firm. If you’re confident that you’ve already made sufficient concessions to please a demanding customer, then it’s time to refuse additional business at any price. Understanding your “customer profitability” is a critical business success factor. Don’t be afraid to send the loss leaders packing to your competition. Let them go out of business.
Rick Balog is Managing Partner of Balog + Tamburri, CPAs in Jacksonville and St. Augustine. He can be reached at (904) 268-1148 or firstname.lastname@example.org