It’s common sense that a company’s most senior executives do all they can to mitigate or avoid unprofitable customers and unnecessary internal activity, yet even the most savvy leaders are mesmerized by the human and institutional bias to capture all possible revenue.
This article is the first in a series of articles that explores the topic of individual customer profitability, where we’ll cover our findings:
- It’s importance as a business imperative (for those with P&L responsibility)
- Why/how does this become a significant competitive advantage?
- It’s direct and positive impact on your EBITDA
- How to maximize and best execute the findings into your new pricing and customer policies.
Profitability is on every P&L owner’s mind, but how important is examining customer profitability?
All profitable businesses should examine their customer profitability every 3 years. Given how few companies do it at all, this might appear as a particularly bold suggestion. Here’s why it makes sense: There are a tremendous number of internal and external forces which affect your company’s overall economics over the course of 3 years, and the financial benefit of repeating a customer profitability analysis always offsets the resources and cost required to conduct the exercise.
Dispelling Common Myths
Setting aside our suggestion to make a customer profitability exercise a routine, let’s look at why even those companies who would benefit most, often object under what ultimately is false rationale. The 3 most common objections we hear:
- “We’re already looking at customer profitability”. If you are indeed, fantastic! However when we examine a client’s financial math, we often find companies are not looking at all their costs of servicing the customer. They are tracking and paying attention to what they perceive as their significant variable expenses in servicing them – in some cases as low as 25% of the their real total costs. The truth is, most companies’ accounting systems effectively and unwittingly bury most of the costs you should be attributing to servicing your customers.
- “We’re prioritizing growth over profitability right now”. First, let’s revisit the fundamental purpose of running a business: to maximize earnings to continually invest in your business’s growth while rewarding stakeholders. Capturing revenue regardless of its near or mid term profitability often makes the business “feel” like its succeeding, but ultimately it only creates work and risk without financial benefit. It is therefore illogical to prioritize growth over profitability unless you have a defined, within-reach milestone at which point the unprofitable revenue can be calculated to indeed become profitable revenue.
- “We’ll need to make some high-risk changes to pricing, which prospects we disqualify, and even fire some customers”. Your pricing is not a “one trick pony”. Highly disruptive changes are rarely required in order to make a customer profitable. Instead, a company can adjust its service levels, sell using an inside sales team, and adjust the numerous policies related to doing business to make customers more profitable.
How Knowing Customer Profitability Becomes a Competitive Advantage
Companies that have examined their customer profitability and effectively acted on the findings normally add to EBITDA by as little as 3%, and up to 10%! In addition to the strength yielded from greater earnings, a more subtle and powerful strategic outcome is the effective creation of a competitive weapon: In cases where no adjustment to policies or practices make a customer profitable, and when these same underlying economics likely apply to your competitor, “gifting” an unprofitable customer to your competitor (who as stated above is likely not aware of their customer profitability) is not only a sound business decision for you, but funnels problematic customers to your competitor.