Researching your customer base can help improve your earnings and turn unprofitable customers into assets.
The prospect of losing customers is a scary proposition for any business in this economy. The recent recession and crawling recovery have made businesses extra protective of their customers — and no one wants to let a customer get away when there’s a chance they may not be able to find a replacement.
But a maximum customer load doesn’t always translate into maximum profits, says Bill Wade of Wade & Partners. Some customers simply don’t make money for companies, and Wade says those unprofitable customers can go a long way toward limiting a business’s yearly profits.
The solution is simple: make those customers profitable or let them go.
Improving a customer’s value to your organization isn’t an easy task. In the aftermarket, what makes a customer unprofitable — or profitable — depends on a number of factors.
According to Wade, these factors include product margins, order sizes and schedules, delivery rates and schedules, customer service requirements, service shop requirements and payment plans.
Since each customer’s requirements are different for each factor, Wade says a distributor must investigate its entire customer base to discover who costs the most and the least. Only then, he says, can a distributor start working to improve or remove its unprofitable customers.
Investigating your customer base
The first step to turning unprofitable customers into valuable clients is acknowledging you have customer relationships you can improve. If a distributor believes in holding on to every customer it has, no matter what the cost, Wade says it may never reach its maximum earning potential.
“The whole process starts and ends with the ability to assign true cost to what you are providing to a customer,” he says. “You have to be able to look at every (customer), big or small, and decide if you’re making enough from them to be profitable.”
Customers who don’t buy a lot but don’t demand a lot of service still may be good customers, while others may buy more but require so much assistance they’re costing you money.
The 80/20 rule states that a large majority (80 percent) of a distributor’s earnings come from a very small amount (20 percent) of its customers. Wade says it’s the remaining 80 percent of customers a distributor really needs to research.
Customers who don’t buy a lot of products but don’t demand a lot of service may be good customers, while other customers may buy more but require so much assistance that they’re costing you money. Every situation is different.
“Most distributors make almost all of their money from a very small level of customers. Then they maintain profitability on 75 to 80 percent of their remaining customers and just lose their (shirts) on the rest,” Wade says.
“Those bottom-rung customers kill you, and you have to find out who they are and why they are killing you in order to improve (your profits),” he adds.
Keith Ely, managing partner of Keith Ely & Associates, says the best way to research a customer and evaluate its profitability is to keep track of all interactions with that customer over a given period of time.
Ely says one week is not be enough time to get an accurate idea and a year is too long. He believes most customers’ habits can be tracked in two- to four-month timeframe.
While investigating a customer’s behavior, Ely says a distributor should keep track of where that customer falls in regard to gross profit margins on partspurchased, delivery requests, service requests and all other factors.
Ely says gross profit margin on parts is the most commonly emphasized factor, but he adds that a distributor cannot immediately assume a customer isn’t profitable if its margin is below average. That’s where the other factors and costs come in.
Ely says a 16 to 18 percent gross profit margin on parts is a common break-even number in the aftermarket. He says that margin usually allows a distributor enough leeway to provide service to customers, cover its costs and still make a net profit.
When a distributor examines a customer and discovers its margins are 15 percent or less, Ely says the distributor should examine the other factors before deciding to terminate the customer.
“With a customer like that, you can’t immediately fire them,” he says. “They may do everything the way you want them to, and they still may be profitable even though the margin is low so you can’t just remove them. That’s when you move on to the other things; the delivery requirements and service requests.”
Delivery schedules can be a major factor in a customer’s lack of profitability. Ely says it’s not uncommon for a delivery plan that was profitable in the past to become unprofitable.
Customers receiving a truck full of products daily can lose their value if that truck becomes 25 percent full.
Customer service and ordering procedures also can make customers unprofitable.
“You have to track everything, including ordering procedures because that can make a difference,” Ely says. “If you have customer who calls in to order parts and takes up your parts guy’s time on the phone when he could order online, that’s hurting you.”
At Kroeger Equipment & Supply, President Bruce Greer says his company tries to track order requests and corresponding returns. “If a customer turns around and returns half of what we deliver him every week, that doesn’t help us at all.”
Customers who don’t order a lot of products, order inconsistently or only order items on discount also can cause financial headaches.
“You have to be aware of the opportunistic customer,” says Guy Blissett, wholesale distribution lead at IBM and author of Facing the Forces of Change. “A customer who only buys products he can get on smaller margins is going to cost a lot more.”
Blissett says opportunistic customers usually look for sales, favorable delivery schedules or other promotional discounts when choosing a distributor. In many cases, these customers may buy 20 different products from 20 different suppliers.
Identifying these customers quickly is important, he says, because more often than not they will leave at the first sign of rising prices or service changes.
The opportunistic customer is focused on cost and nothing else, Blissett says, so working with them to become profitable is unlikely compared to a customer with whom you have a long-term relationship.
The last step in researching a customer is looking at how a customer pays his bills.
The recent recession caused many customers to adjust their payment habits, which in turn forced distributors to carry these customers much longer than they have in the past. As the economy works its way out of the recession, Wade says some customers are getting back to their previous billing cycles. The ones who still are behind, he says, may be falling into the unprofitable category.
“If a customer always has paid in 30 days and now he’s paying in 60 days, or even 90, that’s bad for you,” Wade says. “If it happens once or twice maybe you can stand it, but you can’t let that become a standard.”
Understanding your customer base and knowing the reasons why a customer is falling behind is very important in these situations.
A distributor has to be able to predict that customer’s future buying habits — and future payment plans — in order to decide how to handle moving forward. And if that means letting a previously good customer go, Wade says so be it.
“I know one company that had a contract with the state of Illinois — which used to be a huge contract — and they had to let (the state) go,” he says. “They were paying every 180 days and then tried to push it to 270 days. Who is going to put up with that?
“The company couldn’t carry the state like that for that long. When the contract came up they didn’t renew it.”
Addressing the customer
Once a distributor knows which of its customers are unprofitable, the next step is to meet with each customers and work to come up with a solution.
Ely says it’s important for a distributor to have a proposed solution ready before meeting with a customer. When both sides sit down, he says the distributor should first outline the problem and then detail the suggested solution.
A meeting of this nature has potential to become heated, so Greer says it is important for the distributor to speak clearly and use facts when presenting the problem and the solution.
“If you know your customer base and you know your profits are eroding somewhere, you really can’t be afraid to take a stand,” he says.
“We’re all trying to survive and we all have to make some money. We have to meet each other halfway. You have to tell them, ‘We can’t keep doing this this way.’ Be honest with them, and then be honest about how you want to fix it.”
There are multiple ways to turn an unprofitable customer into a profitable one.
Wade says the easiest solution is a price increase on products and services the customer buys. Raising the margin raises the gross profit from the customer and covers the additional costs they generate.
If the customer agrees to the price increase, he quickly moves back into the profitable category. And if he refuses and walk away, Wade says that loss still can be a positive.
“A loser customer is a waste of your resources,” he says. “He’s costing you on inventory, your salesmen’s time, your delivery costs. Everything. If he also isn’t willing to work with you, let him leave. You’ll benefit more from not having to serve him.”
In this situation, Ely says good customers who appreciate your business should understand the reasons behind your price increase and may be willing to work with you.
Not every customer will, but he believes some may step up and agree to the price increase.
“If you can do a really good job of laying out the increase — why you need to raise prices, what your goals are — then I think most customers we’ll get that. They’ll try to work with you,” Ely says.
“Some are going to say ‘Go pound sand, we’ll take our business elsewhere,’ but I think a customer who truly values your service will stick with you.”
Changing delivery and ordering procedures also can help bring a customer back from the brink, and both are less aggressive than a sudden price increase.
“The services you provide are a good place to look,” says Wade. “If you’re providing free delivery to someone, maybe you can cut that out and start charging a little. Another thing I’ve seen guys do that’s been successful is ask ‘Do you really need daily delivery?’ If the customer says once or twice a week will do, maybe that’s all you need.”
No matter what your solution is, Blissett says you have to back it up with facts — both for yourself and for the customer. Addressing a customer is a business decision and you have to keep it that way.
“The days of going on impulse and gut are behind us. You have to have data and insight,” he says. “You need to have facts to tell a customer that what you currently are doing is unsustainable and that their business is hurting you. You have to tell them why.”
At that point, the next step depends on the customer. He can accept your plan, reject it and go elsewhere or offer a compromise of his own.
If a customer responds with a compromise, Ely says you should evaluate it using the same factors you used to make your initial decision. Just make sure not to look at the compromise as a solution for all unprofitable customers.
Every customer is different, and he says you must treat them as such.
“There’s not a benchmark for everyone,” Ely says. “You have to evaluate each customer. At the end of the day, you have to ask yourself, ‘Is it worth it for us to deal with them?’ If it is, you should always try to make that business relationship work.”
After The Breakup
Watching a customer walk away can be tough, but not all breakups need to be permanent. A distributor and customer parting ways for specific reasons always should be open to reconciliation.
It’s the smart business move.
“As long as a divorce is professional and when (a customer) comes back he is treated in a professional manner, I think you can re-open that business,” says Keith Ely of Keith Ely & Associates.
Since the most common reasons for severing business with a customer are financial or unreasonable customer requests, Ely says it is important for a distributor to remind a returning customer that its policies have not changed, and that its goals remain the same.
If a customer’s reason for leaving was a proposed price increase, Ely says a distributor should stand firm on the increase before taking the old customer back. Accepting that business again at the previous rates quickly will cause the same problems to recur, he says.
“I think the conversation has to start with ‘Can you tell me why you are coming back?’ If they tell you they can’t find the service you provided them, or they can’t find a price that works for them then they probably will be open to your previous proposition,” Ely says.
“But the conversation you previously had has to stand. You have to tell them, ‘These still are my expectations, and for us to take you back you have to meet them.’”
Bruce Greer, president of Kroeger Equipment & Supply, says a positive and professional interaction during the initial breakup can make the reunion easier for both parties. A customer is more likely to return if you gave him reasons why you needed to part ways in the first place.
“If you speak from the heart and you’re honest and professional you can work through just about anything,” he says.
Customers never want to hear they are being let go or dropped, but Greer says they can understand the move and its motives much easier if a distributor speaks honestly.
“If you have a customer who you just can’t please, or you can’t seem to make the relationship work, you just have to tell them that,” he says.
“If it doesn’t work, it doesn’t work. That’s how things are sometimes. It’s not personal, so tell them it’s not personal. Tell them you just aren’t making enough off your margins or whatever it is. It’s a business decision and you have to tell them that.”
But if an ex-customer tries to return without acknowledging your past problems and concerns, he probably isn’t a good customer to take back, says Bill Wade of Wade & Partners.
“Say a guy was a pain when you let him go, and then he went across town and was a pain over there before they let him go; you have to be aware of that before taking him back,” Wade says, noting a customer’s ability to change is the most important factor in them returning to your business.
“If they didn’t work the first time, you have to decide, ‘Have they changed enough to work this time?’”