One of the most valuable assets of a company is its customer base. Customers are the raison d’être (reason for being) for a company. Essentially, a symbiotic relationship exists between a company and its customer base: You nourish customers by providing goods and services that they need, and they nourish you by providing the funds that a company needs to survive.
Yet many times companies get into relationships that are destructive to one or both parties. It is ironic that often companies don’t even realize that they are dealing with an unprofitable client. An example of this is a small advertising agency that was in a downward profitability cycle. The agency had been covering its losses through borrowings from an especially tolerant bank each year. Upon examination of its customer base, the agency discovered that the local arts alliance (which represented the symphony, theater, etc.) composed 40 percent of the agency’s business. The agency was charged with assembling the program booklet for the symphony and theater and obtaining the advertisers in the program. Theoretically the volume of advertising in the program was supposed to cover the cost of designing and printing the program. Due to the extensive effort in obtaining advertisers, which was outside the normal scope of my client’s services, the net effect was a loss to my client annually. In other words, he was digging a hole from which he would not be able to emerge.
Because the arts alliance provided 40 percent of the advertising agency’s business, the owner was absolutely in terror of surrendering the client. We formulated a plan to turn a liability into an asset. Because the arts alliance loved the ad agency’s design, we had a platform from which to operate. We put together a proposal that let my client continue to design and print the programs at a price that would allow him a reasonable profit and move the responsibility for obtaining program advertising to the alliance itself. We knew that there were other agencies that would compete for the business, but the relationship was good and the client liked the product. We also had a plan for modifying the overhead structure of the business in the event that we lost the alliance and the 40 percent of the agency’s business it represented.
Fortunately, the alliance accepted our proposal and the business began digging itself out of the onerous debt structure. We also formulated a plan to reduce the arts alliance business from 40 percent to 15 percent of the sales by increasing non-alliance-related business.
Many companies do not know what percentage of their profit comes from which customers. I have been amazed by what a customer-by-customer profitability analysis has shown me. This kind of analysis helps answer the following questions:
What is the margin I receive from each customer?
Is the customer covering my variable costs?
Is the customer covering my fixed costs?
Is the customer contributing a profit?
Am I expending effort on a customer who is growing? If not, is it better directed elsewhere?
Can I improve my profitability on this customer or do I need to say “no thanks”?
Am I overengineering my product or service to this customer?
In Figure 4-1, I provide a template for a customer analysis.
Table 4-1. Customer Analysis Template.
Customer | Products Purchased | Sales $ | Var $ | Fixed $ | $ Profit | Other Support | % Profit on Sales |
|---|---|---|---|---|---|---|---|
The analysis identifies the customers, what they buy, the fixed and variable costs of what they purchase, and the gross profit from those purchases. Also, the analysis accounts for the cost of “other support,” such as free freight, special discounts, special warranties, cooperative advertising, and placement premiums. The obvious objective is to obtain a net pretax profit on a specific customer and what he or she purchases. As I stated, I have never failed to be amazed at the results of such analysis. Often the customers who I think are my best are in reality among the worst.
An example of this was a large-volume big-box chain whose demands were great but which could offer my client, a manufacturer of sports apparel, extremely high volumes of sales. Its approach was to order several thousand dozens of product in the exact color and size assortment that it needed. In addition, there was a date certain for delivery. We had to sew the retailer’s label onto the product and attach specific hang tags that contained its pricing and bar codes. We also had to provide the product on hangers, ready to hang in the stores. This chain’s stated condition of doing business was payment 60 days after delivery of goods.
Since my manufacturing operations were integrated back to thread, we would spin the thread, weave the greige goods, dye the fabric, cut the material, sew the goods, sew in the specified labels, put on the hang tags, assort as required, put the goods on hangers, and ship the goods by the agreed-upon date. Sometimes, near the shipment date, this large customer would “decrease” the order because “sell through” of the product had changed as the fashion demand for our product had changed. We would then be forced to dispose of this excess inventory in a secondary discount market.
Through the customer profitability analysis, I found that the cost of all the special services we offered the large retailer, combined with occasional product refusal and long payment terms, put this customer’s profitability well into the red. It was especially hard to make the decision to drop this customer because of its volume. The competitive nature of the industry did not allow for price increases significant enough to cover the cost of doing business, so we decided to wind down sales to this customer over time while reducing overhead, including the closure of one facility, and redirecting our sales to more profitable channels.
In another instance, I was forced to oversee the liquidation of a company that manufactured a critical component for an automotive company. The component was a very precisely manufactured technical family of products and was the sole supplier for the automotive manufacturer. Over the years the automotive company had squeezed the component manufacturer for price concessions to the point where there was no profitability. After several years of losses, the investors and the bank were facing “lender fatigue” and wanted out of the company. I was given no option but to liquidate a 100-year-old business that might have been saved had the company performed a customer analysis at an earlier date when other options were still available.
The hardest thing a company can do is fire a customer. There are reasons for doing this besides obvious economic ones. These can include the following six things:
Overly demanding service requirements
Consistent slow pay and collection problems
Exaggerated warranty demands
Continual threats of legal action
Quality requirements beyond reasonableness, coupled with high returns
Abusive or dishonest relationship
Firing a customer, as I have illustrated, can actually be a constructive process and should not be an emotional decision. It should involve the following four steps:
Determine what the economic cost of the customer is in real dollars. Quantify each service and demand of the customer, and determine what you must charge in order to recover these costs.
Have a frank discussion with the customer to determine if you can modify its demands to make doing business together worthwhile, for example, agreeing to more acceptable payment terms.
Raise prices and put the continuance decision into the customer’s court.
Prepare your organization for the loss of business by reducing overhead.
Because customers can actually drain profit rather than generate profit, companies should perform customer analyses often, perhaps every six months. Sales conditions and product mix change. With a new customer I recommend a review of the account’s performance after the first three months of service. This simple review will often avert a great deal of angst in driving continued profitability for your company.