How do you know if a customer is profitable?
How do you assess the value of a customer? This is a critical part of building your business.
It is important to note that value is not limited to how these consumers are contributing to your cash flow. You should also consider factors like customer loyalty — how long they have stuck with your business. Additionally, think about whether and how they drive offer customer groups to your organization. Referrals also contribute to the strength of your brand. Remember, too, that individuals or groups like thought leaders and influencers may not be creating monetary or tangible profits, but they could be encouraging others to invest in your company and promoting awareness in their followers.
Moreover, think about how much a particular customer costs you. Are you spending less on them than you’re putting forth to retain them? Or is the reverse true? Factor in marketing efforts, customer service, and other aspects of customer service to calculate and evaluate this metric.
You should routinely conduct a customer profitability analysis for your clients. This will allow you to see how much profit each individual consumer is adding to — or detracting from — your revenue. It will also enable you to strategize about whether you should put the effort to retain or even divest customers. The good news is that there are plenty of tools available to help you with this process, including software dedicated to conducting and providing data about this kind of analysis.
What makes a customer unprofitable?
In a nutshell, a customer is unprofitable if they are using more of the resources than they are contributing to your business. In other words, they are demanding your energy — including time and money — without paying off in terms of tangible or intangible profits or rewards.
But it’s a little more nuanced than that. Remember that you can reap intangible rewards from your consumers and clients, so it’s not as simple as assessing the monetary profit or lack thereof from each customer. However, it is fair to say that if you’re spending more on a customer than you’re receiving in return, or even if it’s a draw, then that customer is unprofitable.
Why is customer profitability important?
You probably know intuitively why customer profitability is so important — if a customer is not contributing to your business in a meaningful way, they are hurting rather than helping. But more than that, assessing this metric will allow you to assess your overall business strategy and see whether there are products or services you should reevaluate and reconsider. In other words, it’s not just about what your customers are doing — it’s also about what you’re doing.
Moreover, taking a close look at customer profitability will enable you to better understand your consumers themselves and how they are using your products and consider and reconsider your customer acquisition efforts.
Your unprofitable customers are killing you
Quantify them because your unprofitable customers are, to put it bluntly, hurting your business. This extends beyond your bottom line, affecting your relationships with other customers, suppliers, vendors, and more. You need to prevent the issue from escalating and damaging your organization further.
What can you do with nonprofitable customers?
1. Reassess the Relationship
Determine why the customer has become a “problem.” Consider your company’s overall relationship with the customer, not just profitability. For instance:
- Is a customer who’s unwilling to spend (and therefore “unprofitable”) simply unaware of the range of services you offer?
- Have the customer’s needs changed?
- Has your company’s strategic focus changed, causing you to ignore (and offend) the customer?
2. Educate Customers
Provide information or training to help “problem” customers better understand and use your offerings. They’ll have fewer questions—and less need to constantly use your firm’s expensive resources. Example:
Fidelity Investments identified low-margin customers who were frequently phoning service reps. Instead of divesting them, Fidelity taught them to use its other (lower-cost) troubleshooting options, such as automated phone lines and the company Web site.
3. Renegotiate Your Value Proposition
If education doesn’t improve things, consider pricing and service strategies that restore the balance between the costs of serving the customer and the benefits generated. Example:
A supplier of commercial dyes for heavy machinery started charging extra for on-site service to some unprofitable clients as part of a renegotiated price structure. What could have been an obvious divestment situation became a win-win scenario for the company and its customers.
4. Migrate Customers
For still-unprofitable customers, consider moving them to a different distribution channel, a partner company better positioned to satisfy their needs, or a new form of payment. Example:
Satellite TV service provider EchoStar Communications created a prepaid service option for customers with bad credit history, thus migrating them to a different form of payment.
5. Divest as a Last Resort
If there’s still no hope of continuing a relationship with a problem customer in ways that offer enough value for both sides—even after going through steps 1 through 4—it’s time to end the relationship. But do so in ways that mitigate any negative fallout for your company. For instance:
- With B2B clients, communicate your decision to divest months before a contract-renewal date comes up. Explain your reasoning in person, and help clients recognize that termination may be mutually beneficial.
- With B2C customers, provide advance notice in person or by a human voice rather than by an after-the-fact email message or letter. Also, focus your explanation on external factors (such as mounting competitive pressure to change your strategy) rather than simply a desire to increase profits.
The Customer Divestment Continuum
The first reason to divest is, of course, profitability. The popular press is filled with stories about B2B and B2C companies that have divested themselves of customers that no longer provide sufficient returns on investment. This is a fairly common situation in the finance and insurance industries, where profits depend so much on clients’ risk factors.
Another reason to divest is to increase employee productivity and morale. Unduly rude and habitually obnoxious customers can impede employees’ ability to get their work done and even their desire to stay with a company.
Finally, some companies view customer divestment as a natural, if somewhat intentional, consequence of their evolving strategies. When organizations decide to stop offering certain products and services, or when they exit entire business segments, they’re indirectly telling customers to find other vendors that can meet their needs.
When is customer divestment risky?
The fact is, customer divestment is always a risk. And you must take that risk into account before you make the decision to stop serving a particular consumer or client.
Factors you should consider before taking the plunge include:
- The referrals the customer has made or has the potential to make
- The influence they have on other customers or potential customers
- The value they have offered you in the past
- The possibility of exclusivity arrangements
- The effort and resources you will have to put into acquiring new customers and retaining existing (profitable) ones
- Which competitors they could turn to instead and how this might affect your own bottom line
- The potential for bad publicity
- The customer experience they have received so far
- The longer-term implications of divesting
- The lifetime value of each consumer
- How employees could be affected
- Any legal implications
Managing the Divestment Process
Obviously, customers and firms must engage in a transaction that is mutually beneficial. However, this equitable exchange of value can be difficult to maintain over the long term. Divestment creeps into management’s thinking when the value provided to customers grossly exceeds the value extracted. Nevertheless, this strategy should be exercised only after carefully studying relationships with customers in context and making every effort to restore equilibrium. Our customer divestment framework can guide you through that process.
How to Approach Customer Divestment
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