Why focusing on your most profitable customers could prove costly
It is often said that 80% of an organisation’s sales come from 20% of their clients. So should you concentrate on the most profitable 20%?
A recent video on the Financial Times website was entitled, “Are Profits Still a Good Thing?” The video was concerned about investment, but it made the point that in some places the profit motive itself is under attack for fostering inequality, as well as other reasons more often to do with political correctness than economic reality.
Businesses exist to make money for the investors, by anticipating and satisfying customer demand. If a business does not make money it makes a loss. In other words, instead of the business generating income from its customers, the cost of providing the goods or services comes from the capital of owner investors. The business then fails when it runs out of capital to fund the service or product. Even so-called “not for profit” businesses have to make a profit rather than break even, in order to provide money to reinvest in the project if it is to be sustainable for the long-term.
For the marketing manager responsible for producing a continuous stream of profitable income for the long-term benefit of the organisation, balancing the need to make profitable income against the interests of the customer is paramount. Contrary to what some may believe, customer satisfaction is not the main objective of business. Customer satisfaction is important, but customers can be satisfied by the provision of free goods and services.
Ultimately, it is the customer who has the power, because they have the money. The objective of the marketing manager is to maximise the level of profitable income for the long term while minimising the use of assets and investment, by managing all resources efficiently and effectively.
Profitable income comes from sales to customers. Although responsible for the level of profitable income, marketing managers are not responsible for the overall profits of the business. While marketing managers are responsible for most of the variable costs of producing income, fixed costs are the responsibility of the financial officer and chief executive.
The less profitable 80% of the customer base also contribute to overall income production, so it is important to consider how exactly those customers contribute to the interests of the business.
It is generally considered that 80% of an organisation’s sales come from 20% of their clients, thus it is often thought that the 20% of the customer base which provide the most profitable income is the area on which the business should concentrate. However, the less profitable 80% of the customer base also contribute to overall income production, so it is important to consider how exactly those customers contribute to the interests of the business before making any decision regarding their future.
Experience shows that it is a simplistic idea that it is better to concentrate time and investment where it already shows more profitable results, rather than where the results are less profitable. However, increasing investment in such a manner and to ignore the less profitable areas without understanding why they are less profitable, can be counterproductive and potentially expensive.
Before making any decisions that might adversely affect the customer base, there are a number of questions and actions that marketing managers should consider:
- How many customers are there, that constitute the 20% and the 80% ? It is important to know how many customers there are and whether or not the customer base is growing, or shrinking?
- Where are they? Knowing where customers are geographically located and the potential for growing the customer base in those areas is important when considering transport and delivery opportunities and costs.
- Is the geographical distribution of customers a factor in their lower profitability? Are there other potential customers in the vicinity of isolated customers that collectively could be developed to greater profitability?
- What do these customers buy? How much do they spend? How frequently? This information may enable changes to be made to the service which would benefit the client and improve the level of profitable income produced.
- Are all customers being offered the right product mix for them? Would customers benefit from other products or services that could be provided - how do you know?
- What might be done for customers that would encourage them to increase their level of purchase of their existing orders. Could their order size be increased with the encouragement of discounts or improved credit facilities as an incentive?
- Do all customers meet the company’s trading requirements in size, order size capability, location? Can this be improved by altering conditions or servicing through other methods?
- Are credit terms suitable or would a change improve cash-flow and profitability?
- What are the real reasons behind low profitability with the customers that comprise the less profitable 80% ?
- Could the admin/service costs of the 80% might be reduced without affecting the customers? Ask the workforce how they would improve the administration system.
All customers contribute to the size of the business and its overall market share. That size of the organisation affects its influence in the market, which also affects confidence of potential customers and ultimately their buying decisions.
Allowing the more numerous but less profitable customers to wither by neglect, in order to concentrate investment on the less numerous but more profitable ones, increases over-reliance on a smaller customer base, which increases an organisation’s financial vulnerability. At the same time, concentrating resources on the more profitable customers is likely to result in the law of diminishing returns, where additional investment may only result in a marginal increase in income, but with reduced profitability. Those customers which might be deemed less profitable, may well be considered as opportunities for potential growth, rather than seen only as sources of cost and low productivity.
Profits benefit shareholders, but also provide investment for the business which ensures employment for the workforce on which the business depends, while enabling the production of products and services on which customers rely.