Is Zero Unprofitable Customers The Way Forward?
The path to profitable customers can be laden with challenges
As we step into the post-Covid cycle, many businesses are getting a chance to do things differently - operating in a new global recovery mode where issues like sustainability, zero waste and green investing are increasingly the order of the day. We ask if zero unprofitable customers should become a part of the drive to sustainability and a post Internet era.
Numerous businesses learn that 80% of their profits come from just 20% of their customers. Pareto's principle has a strange way of gravitating, like a magnet, to certain business principles.
Traditional businesses tend to see customer numbers as a key performance metric. So they don't care if a customer is contributing a lot or a little to the bottom line. This has been amplified by the rise of the Internet, where the race to the bottom for early customer adoption led to products and services often being given away for free.
But for companies that aspire to be size zero businesses, with high profits, low costs and great customer service, the 80-20 rule is vitally important. Or to put it another way: it’s important to have zero unprofitable customers.
Admittedly it’s not easy. You may have more unprofitable customers than you think. In one case reported in Forbes, a family business with 1,100 customers found that 350 of them weren't contributing to the bottom line. Quite the opposite: the company was losing $2 million a year by servicing them.
Another example is the insurance firm Marsh & McLennan, which politely asked thousands of customers to leave after discovering that 25% of its client base was unprofitable.
Covid-19 has forced entire sectors such as bars, restaurants and theatres to completely rethink their customer pricing and proposition given that their venues have been forced to cater to a smaller number of on-premise customers.
Hanging onto unprofitable customers is not just going to hurt your balance sheet. It's also going to damage your reputation with the customers that do keep you afloat.
The reason is simple. In most cases, customers are unprofitable because they demand more of your services than they pay for. That means other customers that do pay more are getting less of a service than they deserve.
HBR case studies examined a leading plumbing products manufacturer. After an accounting review, they discovered that just 1% of their products accounted for 100% of the operating profits. The most profitable 20% generated more than double that amount, but the extra gains were canceled out by the company’s unprofitable products, which generated losses equivalent to 120% of profits. The customer story was similar: The most profitable 1% of accounts generated 100% of profits, and the top 10% accounted for nearly double that amount. The remaining 90% of customers were either break-even or a drag on the bottom line.
At a “SKU rationalization meeting,” the team classified its money-losing products into four action categories: drop, reprice, redesign, or take no action (for products that had been ordered by important customers or were unprofitable only because of internal process inefficiencies). The company soon had a plan to eliminate or modify nearly half of its 6,000 SKUs.
They also decided that they should sever ties with some of their loss-making customers—especially the least-profitable 1%, among them one of their largest customers, whose accumulated losses had cost them 40% of the company’s profits.
So what can you do with unprofitable customers? The obvious answer is to let them go. But the process has to be handled delicately so as not to upset them, your other customers, or the employees who have invested time and effort in building loss-making relationships.
Four things that you should probably not do with unprofitable customers are to introduce across-the-board price hikes (because you may hurt profitable business), selectively allocate costs, confuse profit with revenue… or get emotional. Dealing with unprofitable business is purely a business decision.
Not should you be shy of making tough decisions when you need to. A recent Harvard Business Review study discovered that 90% of executives interviewed had thought about divesting customers and 85% had actually gone ahead with it. Business sustainability seems to be becoming an increasingly important trend.
Once you have said goodbye to your unprofitable customers, it's time to renew your focus on the most profitable ones.
This process starts at the customer acquisition phase. The Oregon-based IT managed services provider Convergence Networks, for example, is said to have boosted revenues by 9% in one year after turning away 90% of new business opportunities and simply focusing on the four new customers worth most.
Convergence is not some fly-by-night operation. It’s a multi-million dollar business with a 97.5% customer satisfaction rating, listed among Oregon’s top 100 employers and top 100 growth companies. And when it comes to unprofitable customers, it's clearly a size zero business.
We have identified five steps worth taking when considering the shift towards zero unprofitable customers:
Reassess. Find out not just which customers are unprofitable, but why. Have they been left behind in a change in company focus, for example? Are they simply on the wrong products, plans or programmes? Could a few simple measures make them profitable for your business?
Educate. If customers require a lot of servicing it may be because they are suffering from a knowledge gap regarding your products. Check to see if your product details, supporting manuals, training and so on are up to scratch. Make sure you set the right expectations in your marketing and sales process. Promote automated help desk services and self-service channels.
Renegotiate. In many cases it may be worth speaking to your customers about paying more for the unprofitable services they use. To do this, you need to clearly articulate your value proposition and show why it makes sense for the customer to pay extra. Importantly, having this conversation helps to set the scene if you need to take things to the next stage.
Migrate. For customers where renegotiation is not going to work, you can take matters into your own hands and shift them onto a lower service level. This could mean moving them onto a self-service channel, for example, or delegating the relationship to junior or outsourced staff. Another option is to refer the customers to a business partner that is better set up to take on the work, perhaps in exchange for a small finders’ fee.
Terminate. If all else fails then it makes sense to end the relationship. The critical thing is to use tact and diplomacy so you avoid negative fallout. Make sure you communicate the decision well in advance and where possible attempt the others measure outlined above beforehand.
As we move into a new post-Covid world it makes sense to take stock and consider whether a path toward zero unprofitable customers will help you develop a more sustainable and focused route to the future. At a minimum the exercise should reveal valuable insights into your products, pricing and customer dynamics. Given that Covid has turned everything on its head - who knows where it might lead you.
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