Study Your Customer Base

It's obvious that without customers, your company wouldn't be in business. But not all customers are alike. Some account for a big percentage of your profit, while others' contributions may be negligible.

It's entirely possible that about 10 percent of your customer base is costing you money. While they contribute to the top line, they sabotage the bottom line in any number of ways. For example, they may demand that you turn on a dime and need lots of hand-holding. You may even find that your biggest revenue-generating customer is a liability if you've slashed your profit margin until it bleeds and committed top management, large chunks of time, and extra resources to servicing the customer.

A useful exercise is to segment and study your customer base -- the top 10 percent, the bottom 10 percent and another 10 percent with high potential. Here's a basic four-step plan:

  1. Identify the 10 percent of your customer base that is most profitable and analyze what characteristics they have in common. It may involve factors such as product type, optimum order size and frequency, and how their needs mesh with your core competencies.
  2. Do the same analysis of the 10 percent of your customer base that is least profitable or unprofitable. If at all possible, avoid "firing" customers, especially if they have growth potential. If you must fire a customer, do it in a respectful, professional manner. In a face-to-face meeting, let them know it's all about profitability. Resist any temptation to tell them what a pain they've been.
  3. Look for ways to turn unprofitable customers into profitable ones. Start by cutting costs through eliminating meetings and sales calls. Not only do these activities often expend resources, but they carry opportunity costs. You may need one face-to-face meeting with each of these customers to explain things like your salespeople won't be calling, extra services will no longer be free, prices will increase and delivery charges will go up.
  4. Take the resources you're freeing up and direct them toward retaining the top 10 percent of your customers. Then, look for another 10 percent that have high potential for improved profitability. These two groups are the customers who should be getting most of your attention.

ABCs of Profitability

It can be hard to get a handle on customer profitability. The surest way is to do activity-based costing (ABC) that shows how much money is spent on each activity, including sales, order processing, receiving, set-up, shipping, billing, etc.

Then, determine how much of each activity is allocated to each customer. This type of analysis reveals where customer costs and revenues are out of whack, and provides the basis for making changes toward greater profitability.

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