You pick up the phone, it’s “them” again– you know, the customer that calls and complains, who needs everything delivered yesterday and who pays late? You are miserable serving them but, hey, they are one of your best customers—they buy a lot and have done so for years.
News flash: It might be time to give them the ax.
“Are you crazy?” you may be thinking, “In this economy when business is down 50% and I am struggling to keep the few customers I do have? Why let them go?”
Because you just might make more money if you do.
Studies have shown that the 80/20 rule applies to profits as well as sales. That means that a typical company makes no money or loses money on 80% of their customers. Measuring customer profitability is a powerful tool to improve your profits especially in this economy.
Here’s a simple example on how getting rid of a profit-draining customer (Customer P) can boost your bottom line.
Even though sales without Customer P have been nearly halved, profits have increased by 50%, and margins have more than doubled. You won’t get results like that with typical cost-cutting measures.
Here are some steps you can take to handle money-losing customers
- Do the math. The first and obvious step is to find out who are your 80%. You’ll need to look beyond just gross margin (the money you have left when you take out the direct material and labor costs of your product or service.) Factor in distribution costs, expediting, post-sale service, “gratis” goods or services, and borrowing costs if they pay you late.
- Show them your cards.
Customer profitability is most powerful when it is shared. Super-charge your discussions by showing them where they stand vs. their competitors that are profitable for you. These can be shared without disclosing confidential information by using percentages of sales and masking names.
- Love them (back to profitability). You should always try to find a way to turn money-losing customers around. Now that you know in detail the cost to serve them, you have specific areas you can target for reductions. You may find that the discounts you have been giving them have cut into your profits or that you need to raise your prices. It’s also a good time to look internally and see how you might be able to pare back services that are not adding value to them, but that are increasing your cost base.
- Leave them. If they aren’t willing to work with you to reduce costs or agree to price increases, it is time to let them go. Maintain goodwill by helping them find another supplier, but be firm that the relationship has to end. It may mean the difference in your survival in the market.
Measuring customer profitability is probably the single most overlooked measurement to boost profits in this economy. It allows you to cut costs with a scalpel rather than an axe, and has greater impact on your bottom line than slash-and-burn tactics will ever have.