This is where careful management of customer lifetime value or customer equity comes in. Take the high-revenue, low-cost customer. These are customers who, by definition, have the highest lifetime value. They are also the customers who are most likely to be attractive to the competition, so the correct customer management strategy here is to retain them.
Some companies do this by offering longer-term contracts to these customers; others tie them in with shared information systems, longer-term pricing or shared processes.
Another group is the high-revenue but high-cost group of demanding customers. These are large customers (high revenues) but the high costs of looking after them might mean that they are not particularly profitable. The trick with this type of customer is to retain the high revenues, but manage them with less cost. This might mean incentivising them to move to cheaper channels (such as Internet ordering); or it might mean renegotiating terms.
Most companies have a large number of customers who fall into the ‘commodity customer’ category. These are low-revenue but low-cost customers. In other words, they generate relatively little business, but their costs are low. The most effective strategy with these customers is to contain the costs of doing business with them. It is bad strategy to develop costly new value propositions for customers and then to offer them to this group. Either they cannot afford them, in which case it is a waste of sales and marketing time; or, perhaps worse, they flock to the new offer in droves, reducing the company’s ability to service its more valuable customers. Marketing needs to be targeted to ensure this does not happen.
Finally, there is the fourth group, which has relatively low lifetime revenues but reasonably high costs to serve. An example of this occurs in retail banking, where low-profit or no-profit current account customers make heavy use of the branch network. Some retail banks have chosen to shut down branches or to charge these customers for costly services, effectively either reducing their service levels or putting up their prices. Other companies have re-routed this least profitable group through intermediaries rather than continuing to service them directly.
Rule 3. Acquire more profitable customers
‘Only acquire customers who are profitable’ is simple advice, but implementing it is difficult. All too often, sales people are measured and paid by the volume or revenues they bring in, rather than the bottom line. If the sales people are also able to give discounts, it is very tempting for them to do so, especially towards the end of the quarter when they are striving to meet targets. Not infrequently, customers become aware of this pattern and start to delay placing orders until the end of the quarter, when they can be sure of an attractive offer.
So, ensuring that sales people understand the profit impact of giving a discount is important. The second consideration is to recognise that, just because a customer is a good customer, does not mean that all of their business is good business. Not all opportunities are good ones, and suppliers should be mindful that they don’t need to chase every opportunity that comes along.
A useful technique for helping sales people and customer managers to sort out the good opportunities from the bad is the technique of calculating Expected Monetary Value (EMV). This involves thinking about the possible risks and their probability.
In the example shown in table 1 (below), although the most likely outcome is a profit of £10,000 if all goes well (row 2), there would be substantial additional costs for the supplier if the project was an unexpected success, and also if there was an unexpected failure. When these are taken into account, the EMV of this opportunity is not £10,000 but £6,900. The supplier should take this into account when considering how to price this tender. Too often, what looks like good business turns out to be unprofitable because of unanticipated changes to circumstances. Thinking about the risks up-front introduces a measure of objectivity into the tendering process.
The third rule for acquiring customers who are more profitable is to use a rule of thumb, which is that the most profitable customers tend to share certain characteristics. These might include their behaviour patterns, demographics and purchasing processes. Once the company understands what profitable customers typically look like, sales people can try to locate more customers like these. Smart companies also use this technique to filter customers through their call centres and websites. Key questions are used to establish what kind of prospects are contacting the company and whether they are likely to prove profitable. Based on these key questions, the incoming customer can be steered towards certain products and services.
The main messages are clear. The more that a company knows about the profitability of its customers, the more targeted and effective its retention marketing can be. Some simple techniques for identifying profitable customers can help sales people avoid acquiring customers that turn out to be unprofitable. Companies will survive this recession if they: keep their most profitable customers; avoid acquiring unprofitable ones; and take action to manage existing customers that are unprofitable. It’s not enough to think in terms of ‘selling more products’. Many companies who go bankrupt have just had their best-ever year in terms of sales. In hard times, the trick is to focus on getting and retaining profitable business.
