Three customer types you might need to fire

Three customer types you might need to fire

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Given that companies everywhere are under pressure to grow their top line revenue, you might think it is bizarre to be writing about firing customers. However, stick with me for a moment and I will explain why it is sometimes the very best thing you can do.

For a start, let us dispel the myth that every customer needs to be profitable. Most companies have customers they are happy to trade with even though they will never add a dime to the bottom line. For instance, companies marketing new technologies need early adopters to help them develop expertise in specific industries, and will invest huge amounts of time and resource to make the relationship a success. Similarly, companies penetrating new markets tend to discount heavily to win marquee clients that will help them to become established.

However, these are exceptions, and the majority of customers need to generate some level of return. I have used the word “return” because, if you do the math and calculate the profitability of your customers using a solution such as the Anaplan Activity-Based Costing app, you will find they typically fall into three groups:

  1. Smaller customers that generate so little revenue for you that their contribution to overheads fails to fully recoup the indirect costs of doing business with them.
  2. Medium sized customers who make a contribution to overheads that covers the indirect costs of doing business with them and leaves some leftover as bottom line profit. Having lots of this type of customer is generally very good for profitability.
  3. Larger customers that generate a large amount of revenue but typically fail to make sufficient contribution to overheads to fully recoup the cost of doing business with them. Having some of this type of customer is generally good as it helps overhead recovery; but having too many can be a problem.

In real life, inconsistently applied discounting policies and differences in the mix of products purchased make customer profitability more complex. Consequently, these three groups are not as distinct as portrayed here; they blur into each other at their extremities. However, they are more than adequate for highlighting the common problems encountered in managing customer profitability. But first a word of warning.

Firing customers can be dangerous

Unless you are sure that you can remove or redeploy all the direct and indirect resources involved in serving the account, suddenly firing large customers can result in a downward spiral of declining bottom line profitability – exactly the opposite of what was intended. This is because after they are gone you are left with exactly the same amount of overhead but fewer customers who contribute to it. Experience shows that it is better to adopt an incremental approach to customer management and only fire large customers when there is a more profitable new account ready to come on board and soak up the capacity.

Stopping trading with a multitude of smaller customers may result in a similar outcome. If they are paying the market rate for your product or service, it is probably the way you do business with them that is making them unprofitable. So rather than abandoning them to a competitor, it is better to develop a new business model that reduces the costs involved in trading with them.

So with those provisos in place, which customers might you look to fire?

  1. The customer that refuses to accept the new business model

You cannot trade profitably with individual customers that refuse to accept changes in the way you do business, such as moving them to on-line ordering. Pandering to their needs will simply add complexity and cost, so it is better to pass them over to an agent or distributor. But if that’s not an option, just let them go.

  1. The customer that refuses to budge on price

Profitability analysis will give you a guide on the prices different types of customers should be paying if you are to make an adequate margin. If they currently enjoy a level of discount that makes their profitability fall below this level, you should review their terms at the next opportunity. In my experience, one of the common reasons why the profitability of an individual customer is out of step with that of their peers is because their preferential discount rate was based on a promised level of business that was never achieved. Point this out during negotiations, and unless you can make any headway on price, be prepared to say goodbye.

  1. The customer that always asks for more

Some customers are loss making because of the additional direct costs incurred in providing extra services they demand. These can be anything from special handling of deliveries through to giving extended credit terms. Coping with complexity and non-standard processes is costly for any business, so unless the customer is prepared to pay for these value-added services, part company at the earliest opportunity.

Summary

Companies that routinely report on and diligently manage the profitability of their customers rarely need to fire them. However, such companies tend to be the exception. In most, customer profitability management is rarely a continuous or pervasive activity. To my mind, there are two reasons for this. First, it is only recently that in-memory solutions capable of manipulating large amounts of data have made it practicable to run regular monthly or quarterly reports on the profitability of individual accounts. Secondly, the responsibility for customer profitability often falls between the cracks of finance, operations, and sales. However, if it tackled as a collaborative effort and embedded into the business as a continuous process, the investment will pay for itself many times over.                    

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