What Should You Do About Unprofitable Customers?

Unprofitable customers are parasites who suck profits from the bottom line. On average, about 15% of customers are unprofitable. Customer loyalty expert and author Nick Wreden discusses strategies to either increase the profitability of the unprofitable or to dropkick them to the competition.

(PRWEB) June 29, 2004 -- Four years ago, revenues at Skelton Tomkinson, a heavy-machinery shipper in Australia, dropped from $20 million to $8 million after raising the fees on some unprofitable customers and selling the rest.

Such a contraction would cause heart attacks for many CEOs preoccupied with the false gods of sales or market share growth. But firing the unprofitable paid off. Net profits increased 98%.

Unprofitable customers are parasites. Harvard Business Review estimates that, on average, 15% of all customers are unprofitable. In most industries, the best 20% of customers account for 150% of profits. The worst 20% typically lose money equal to 75% of profits.

What can companies do about unprofitable customers?

Nick Wreden, customer loyalty expert and author of FusionBranding: How to Forge Your Brand for the Future has several suggestions.

"To improve profitability, the first task is to identify unprofitable customers. But most companies do not know how to determine customer profitability. Answers cannot be found in traditional accounting systems. Executives are in the dark about what it costs them to acquire customers and keep customers. Some even deny they have unprofitable customers," says Wreden.

Simple customer segmentation by revenue is sometimes enough to spot unprofitable customers, especially if it is assumed that the cost-to-serve and cost-of-goods are roughly equal for all customers. More sophisticated customer equity strategies can identify when you're spending more than you expected on a customer who is worth less than you thought. Some companies just look for warning signs that likely signal unprofitability, such as late payments, excess service calls, numerous returns or frequent complaints.

Once unprofitable customers have been identified, the next step is to increase their profitability, either by increasing revenue or lowering associated costs.

"The right action depends on the answer to this key question: Are customers unprofitable because of their behavior or your costs?" says Wreden.

Every customer should have the opportunity to increase profitability. Here are options Wrreden suggests for changing either costs or behavior:

o Stick to core strengths: Losses result when companies try to do something they are not skilled at. If customers request a service that is outside a competency, either refuse or outsource it to a specialist.

o Raise prices: This is the best option. If the customer accepts the higher price (or lower     discounts), companies are more likely to have a profitable customer. McKinsey & Co. estimates    that a 1% increase in price leads to an 11% increase in customer equity. Some estimate    that 60-70% of customers accept price increases. If the customer rejects the higher price, then an unprofitable customer is lost    and overall profits improved.

o Change policies: Consumer goods giant Procter & Gamble realized that direct LTL (less-than-load) shipments were raising costs. So P&G changed its policy to ship goods in truckload volumes only. As a result, smaller, less-profitable customers had to use distributors, and P&G was able to differentiate its services to larger, more profitable customers.

o Bundle or unbundle offerings: Offer customers    a prix-fixe package to get a better deal, or order a la carte at higher prices. In general, customers generally trade up to higher-priced packages.

o Lower costs to serve: Fidelity Investments uses an automated phone system that identifies unprofitable customers and routes them into    longer queues, so they can serve more profitable customers faster. If the unprofitable customers switch to the Internet, they became profitable.

o Evaluate future profitability: Yes, customers can become more profitable over time. The key determination is share-of-wallet. If you already have a large share-of-wallet, and the customer is still unprofitable, it is unlikely profitability will improve.

If these efforts do not work, then unprofitable customers must be fired."

That suggestion always raises protests at Wreden's seminars. We worked hard to acquire that customer." He is unprofitable today, but he might be profitable tomorrow." Volume is important, so even unprofitable customers help cover the costs of production." Some have worried about a backlash, especially among those who might think unprofitable" means poor" or minority."

"Are those reasons more important than your profitability? Do you really want to keep subsidizing unprofitable customers? Companies drop unprofitable products all the time. Why not unprofitable customers?" asks Wreden.

But it is important to do so gracefully. An unhappy ex-customer can generate negative buzz. Get customers to fire themselves. Keep raising prices, or make processes more complicated. Other steps include not renewing contracts or not accepting orders.

Finally, study the characteristics of unprofitable customers. Then change your marketing. Remember that each new customer who turns out to be unprofitable destroys shareholder value. Stop using PR and marketing campaigns that cast wide nets. Stop sales from ringing bells for every customer win. Use the resources saved to go after the look-alikes of your profitable customers.

A common mistake is to equate sales volume with success: "We're selling a lot, so we must be making money." That is a dangerous assumption, asserts Wreden. If a product or segment is unprofitable, then every new customer hurts the bottom line. Remember the words of Brad Skelton, managing director of Skelton Tomkinson, who turned his company around after concentrating on profitable customers:

I run my company with this saying: 'Volume is vanity,and profit is sanity."

For more information, contact Nick Wreden, managing director of FusionBrand and author of FusionBranding: How to Forge Your Brand for the Future at 770-582-6791.