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 customer profitability analysis 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 analysis 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 or Exit, 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.
Sales activity will grind to a halt. Your sellers are earning a commission on the business, so there is a natural drive to protect the relationship. The accounting reports are based on allocations, which are easy to challenge. Even worse, you start hearing “water-cooler” math about how little it costs to operate a truck or service a customer. Usually out of touch with reality; you need to pay for the truck AND the health care plan, vacation policy, and everything else. But good luck telling that to a salesperson whose commissions are cut. This needs to be debunked as well, to protect morale. Your managers will redirect their time to address this.
And the forth horsemen of the customer profitability analysis apocalypse…. random variation in customer orders over time. This problem shows up when you make the decision to “tighten things up”. All of a sudden, you’re 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.
Customer Profitability – Look Forward, Not Back!
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….
The most critical act in this exercise is to shift the focus of the customer profitability work from accounting to predictive analytics. Instead of fixating on which bets didn’t turn out, use this data to improve your view of what is likely to work – and increase your bets in these areas….
There are ways to use your customer profitability report to accomplish this; we just need to use some different tactics.
Customer Profitability Strategy #1 – 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.
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 prior 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 – 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 customers. 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.
Customer Profitability Strategy #5 – Simplify Sales & Service
The same logic can be applied to the level of time the sales team invests in the least profitable accounts.
Face to Face presentations? Only if you’re profitable or there is a high potential to grow share. Which interactions can we move to phone or email? Would there be value in shifting the business to an inside sales team or an empowered customer service representative? Can we attempt similar activities in service, moving the customer’s delivery dates to a common route or offering them a simplified product assortment?
This needs to be approached delicately. Many sellers have long standing relationships and view their contact with these customers as their primary reason for being with the company. Assuming the seller is still competent at developing new business, this is a great way to frame the opportunity. We’re going to reduce your workload calling on low value accounts to enable you to spend more time with your top growth prospects.
The irony is that many of these changes can actually improve customer satisfaction. Instead of being a neglected account, getting the dregs of an outside sales representatives time, the customer is getting regular communications via an inside sales process and an assigned inside salesperson. For the typical price and availability buyer, this is all they want. The personal visits and the donuts didn’t add value.
Profitability analysis can be used to guide customer segment targeting. You can use your assessment of customer lifetime value to make better decisions about where to deploy sales and product development resources.
This strategy can be implemented in three ways. First, you can use customer value and profit margin as a criteria for when to assign your top people to a prospect. Second, you have the option of converting less profitable customers to low cost sales and service models. Finally, you can use unprofitable customers as an opportunity to test aggressive profit improvement ideas. If the customer accepts the new policies, total profit rises. Should they leave, you’re still better off.
This needs to be approached delicately. Many sellers have long standing relationships and view their contact with these customers as their primary reason for being with the company. Assuming the seller is still competent at developing new business, this is a great way to frame the opportunity. We’re going to reduce your workload calling on low value accounts to enable you to spend more time with your top growth prospects and best existing customers.
The irony is that many of these changes can actually improve a customer relationship. Instead of being a neglected account, getting the dregs of a sales representatives time, the customer will get regular communications via an inside sales process and an assigned inside salesperson. For a price and availability buyer, this is often all they want. The personal visits and the donuts didn’t add value.
The key constraint to this type of restructuring is often social. A particular customer may have built strong relationships with your reps, who have grown comfortable calling on them. The activity based costing helps you separate effort from impact, re-balancing towards the latter. By gentle guiding reps towards different customers, overall profitability is improved.
This becomes a greater challenge if you detect the reps are incapable of winning business in a more desirable customer group. Along the same lines, strategic marketing planning efforts need to be updated to reflect the shift as well.
Conclusion – Looking Beyond The Mathematics
One small change: using the analytics to predict the future rather than argue about the past. But look at what it does for change management!
Speaking as a seller myself, this mandate is lot less scary. Go focus on these three areas for growth (since we know it will work out for the business) and you now have a socially acceptable reason to push back on your worst accounts. Or dump them off to someone else.
More importantly, the sales team hasn’t lost focus on the core activities it uses to create value: finding new business. Instead of descending into the typical panic when a customer profitability report is released, as sellers dig in to challenge the numbers and protect their business.
So keep this in mind the next time your board of directors or Finance team wants to dig into customer profitability….
Small changes but a huge payoff.
- Strategic Pricing – 9 Real World Ways To Earn Higher Margins
- Using Customer Profitability For Good and Not Evil
- Target Pricing – Setting The Correct Focus With Your Sales Team
- Using Yield Management To Improve Overall Performance
- Aligning Pricing Tactics With Your Process
- Measuring Pricing Performance