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Many business owners go to great lengths to hold onto every client they have. But that can be counterintuitive. Why, you might ask? Because in the long run, dropping certain clients can actually help you become more profitable.
Determining individual customer profitability should be your first step when considering which customers to drop. If your business systems track individual customer purchases and your accounting system has good cost accounting or decision support capabilities, this process will be simple. If you have cost data for individual products, but not at the customer level, you can manually “marry” product-specific purchase history with the cost data to determine individual customer value.
Even if you don’t maintain cost data, you can sort the good from the bad by reviewing customer purchase volume and average sale price. Often, such data can be supplemented by general knowledge of the relative profitability of different products. Be sure that sales are net of any returns.
Don’t ignore indirect costs. High marketing, handling, service or billing costs for individual customers or segments of customers can have a significant effect on their profitability even if they purchase high-margin products. If you use activity-based costing, your company will already have this information allocated accurately. Even if you don’t track individual customers, you can still generalize this analysis to customer segments or products.
For instance, if a group of customers is served by the same distributor, you can often estimate the resources used to support that channel and their associated costs. Or, you can have individual departments track employees’ time by customer or product for a specific period.
Categorize Your Clients
After you’ve assigned profitability levels to each customer or group of customers, divide them into certain groups. For example, say the A group consists of highly profitable customers whose business you’d like to expand. The B group, however, is made up of customers who aren’t extremely profitable, but they still positively contribute to your bottom line. Last, but not least, the C group includes those customers who are dragging down your profitability. These are the customers you can’t afford to keep because they’re overdemanding and abusive to employees, expect special servicing and request more time to pay invoices. In other words, they’re in the “no longer profitable” category.
With the A group customers, your objective should be to grow your business relationship with them, because they’re worth going the extra mile for. Spend time learning why they’re your best customers. Identify whatever motivates them to buy your product or service, so you can continue to meet their needs. For example: Is it your products? Your level of service? Some other factor? Developing a good understanding of this group will help you not only build your relationship with these critical customers, but also target marketing efforts to attract other, similar customers.
Your B group customers may be OK, but, just by virtue of sitting in the middle, they can slide either way. There’s a good chance that, with the right mix of product and marketing resources, some of them can be turned into A group customers. Try to identify those who have a lot in common with your best customers; then focus your marketing efforts on them and track the results.
When it comes to the C group, spend a nominal amount of time to see if any of them might move up the ladder — it’s possible if you give them a lot of attention. It’s likely, though, that your C group customers simply aren’t a good fit for your company.
Fortunately, firing your least desirable customers probably won’t require you to call them and tell them to get lost. Just don’t focus on them. Stop spending money by sending them catalogs or other mailings. Also, tell your salespeople to stop calling on them, and don’t offer any additional discounts. After a while, most customers will leave on their own.
It is Time to Say Goodbye?
Every business must regularly evaluate its customers. After all, you’re in business to make money. So, if you have clients that are no longer profitable, it’s time to pull the plug