During challenging economic times, it’s more important than ever to focus on the profitability of your business. What are the keys to sustaining profitable sales? What vulnerabilities might your competitors discover and exploit? And how does the changing environment create customers, cost reductions or other advantages you can snare?
Certainly its important to consider these questions from a grand perspective to develop a sense of the key decisions you face. But these important questions should also be viewed through the lens of your high-value customers: current and future. These are the clients that provide you the highest return for your investments in them, the ones often responsible for 80% or more of your profits.
Yet often, under the strain of difficult decisions, this fuel for profit is ill-defined or, worse yet, its unique needs and contributions are ignored altogether. Frequently, this creates a domino effect: first, sales weaken; next, profitability drains, then, core advantages begin to wither from lack of resources. All too often, the business sputters onto life support and eventually fails. Meanwhile competitors with seemingly comparable offerings thrive or even grow.
What Fuels The Engine?
When your car runs out of gas, you know what fuel it needs: unleaded gasoline, diesel, ethanol, or bio-fuel. You know that pouring in the wrong fuel can ruin the engine. Similarly, defining your high-value customers helps you understand the fuel you must acquire and preserve to keep your business humming profitably.
The Dual-Valve Approach
High-value customers bring you the most profitability because you bring them value. In exchange they return value to you. When you stop bringing that value, they become yesterday’s high-value customer. As both you and your customers change and evolve, your pipeline to profitability must include your high-value customers of today, and those of tomorrow. If either valve closes, the pipeline empties and the engine dies.
Getting a Handle on True Profitability
Today’s high-value customers aren’t necessarily your biggest customers — those with the highest purchasing volume. Many other factors influence the value customers return to you. What does it cost you to sell to and serve them? How long do they stay – like an annuity, what’s their lifetime value? You’ll want to consider each component in the checklist below:
- Sales Volume. How much your customer spends is important; it’s just not the only thing that matters.
- Profit Margin. What’s the profit margin on the sales after you allocate costs? A 10% profit margin on $10,000 in sales is equivalent to a 1% margin on $100,000 in sales, but the $100,000 sale often requires far more indirect resources. Ultimately you want to define your final profit margin, and often the simplest approach is to start with gross margin, then modify for other harder-to-match costs.
- Product Mix. Is this client an early adopter, the viral marketing tool that money can’t buy? Do they purchase a profitable mix of products, or only your most unique items they can’t get from anyone else?
- Acquisition and Retention Costs. What does it cost you to sell to this customer? For example, what marketing, sales, administrative and service costs did it take to acquire the business? EADS and Northrop Grumman spent millions to win the Air Force’s contract for the tanker of the future. And what does it take to keep the customer? Boeing also spent millions in their attempt to win that same contract from the Air Force who was their existing customer, and failed. Don’t ignore resources consumed in persuading and wooing your clients, especially unpaid consulting, proofs of concept, and valuable executive time.
- Costs To Service.This step involves looking for patterns in costs after sale – costs that can vary significantly by customer: return rates, customer service calls, warranty costs, payment timeliness or collection costs. In 2007 Sprint “fired” over 1,000 customers because their repeated calls to customer service demanding credits to their bill was costing thousands of dollars in refunds alone. Costs that were effectively passed on to more desirable customers through diminished service or higher rates. These ‘complainers’ were the 1% of customers making the vast majority of the difference in customer service and return costs.
This cost of service analysis is especially tricky, however, for larger organizations because their internal systems provide a false sense of confidence and validity. It’s easy to forget that these systems were not often designed with your specific analysis in mind, and even if they were, their somewhat “Black Box” calculations are subject to the same garbage-in, garbage-out and pro-rata allocations that infect other data.
Where could differences between customers make a significant impact on net profit? Consider this question systemically, holistically. Then tailor your skepticism and testing accordingly.
- Influence. In every social system, influencers play a disproportionate role to their stated power. Oprah only needs one book, but if she chooses to feature it in her book club, the sale of that one book is worth far more than any other sale. Its value is so significant that most publishers wouldn’t even dream of charging Oprah for a book. We all have our own Oprah we wouldn’t dream of upsetting if we stopped to consider our decisions in those terms. Conversely, do some of your customers have negative a influence on your business, disclosing inappropriate details to the press or making statements that undermine your position with other customers?
- Retention. We mentioned retention costs above, but we didn’t mention the other dimension: how long does that customer stay with you? Retaining customers even for just a year longer generates some of the most dramatic increases available in profitability, often quoted at 30% or more. Of course the difference it makes to you will depend on the characteristics of your offering and your customers. No matter the details, however, the costs of wooing and learning to serve a new customer are so high that in established businesses, it’s rare to find a case where resources are better spent on acquisition than retention.
- Consider the full revenue stream, then allocate realistically. Don’t rely on your accounting system to provide these answers. GAAP accounting is for investors. It doesn’t provide the precision you need. Instead, use your Customer Relationship Management system, other customer service data, and carefully constructed data dives to define truer revenues and costs by clients.
Once you’ve created this estimate, verify the total value you’ve estimated is comparable to the financial results of a selected period. In other words, if you add up your estimated values for this year’s earnings, is it close to actual results? If not, compare the detail until you find the differences that don’t make sense. Make sure your allocation makes sense before moving onto the next step.
- What’s your customer structure? Now that you know who really adds the most profit, what can you learn from your basic portfolio structure? Does Pareto’s Law apply — are you making 80% of your profit from 20% of your customers? As the percentage of customers providing the bulk of your sales decreases from 80%/20% toward 90%/5% or lower, the vulnerability of your business increases. However, this same skew in your results also means you’re likely to discover a lot of “low-hanging fruit” within your existing customer base – fruit that can mature into tomorrow’s high value customers.
Walking The Tightrope Between Profitability and Cash Flow
One of our clients had eye-popping gross profit margins and phenomenally high customer evaluations, but seemed to constantly struggle with profitability and cash flow. Looking at averages per customer, it was difficult to spot the culprit.
However, a quick analysis by type of sale revealed the fundamental issue. Each sale involved a significant set of “per sale” costs that didn’t fluctuate whether the sale was $500 or $50,000. With more than 90% of sales representing less than 5% of sales dollars, the client was losing money on every one of those smaller sales. This was a very expensive form of advertising, and an endless source of headaches. Once the company realized what was happening, pricing was immediately changed to break-even until they could do further analysis (on tomorrow’s high value customers). On the few occasions they did lose a customer because of price, they were happy to pass the losses on to their competitors whose sales teams were often compensated for totals sales, regardless of profit.
As you go through this checklist, you’ll almost undoubtedly discover customers costing you money to serve. If your best customers are funding these profit drains, it’s time to take action. Most would recommend “firing” these customers once they’re discovered, but don’t do that yet. There’s another step you need to complete first. Are some of these the high-value customers of tomorrow?
The Bottom Line
Recognizing your high-value customers can help fuel your sales pipeline and keep your company profitable with the least overall effort. By looking under the hood to discover the nuances of your customer base, you can determine which customers truly make a difference. You’ll understand their vulnerabilities, their common elements, and how they react to the changing environment. By viewing your customer base through the lens of current and future high-value customers, you can more readily provide the value they need before returning value to you.