The smart entrepreneur focuses on growing sales with the most profitable customers, while finding ways to manage less profitable ones. The key is to analyze each customer: how much they spend, how many resources their business ties up and, most importantly, the profits you make on their business.
Individual Customer Analysis
Start by analyzing each of your customers, beginning with your smallest. For that customer, determine:
- Total spending per specific period of time. Use weekly, monthly or yearly figures; choose a time period that makes sense for your business type.
- Cost of goods or services provided. For now, leave out fixed costs like rent, utilities and other overhead. Focus on the actual cost of the goods provided or your direct costs to provide a service.
- Cost of additional "services." Some customers require more administrative or sales support than others. Evaluate this customer against your "average" customer: Do they call more frequently to check on an order status? Do they tend to return more products? Do they require unusual administrative processes? Capture the additional cost (if any) of servicing the customer.
Do the math. Do not include overhead and fixed costs in the calculation. Take the customer's purchased gross revenue and subtract the cost of goods (or services) sold, (sometimes called gross margin), minus the specific, additional cost to service this particular customer. What remains is the profit margin for the specific customer for your business.
Another way of looking at this to make sure the difference between revenue and profit is clear, think of a customer who purchases only your premium product that has the highest gross margin. This customer may buy relatively less than another customer who purchases only your low margin products. But, which of the two customers makes you the most money? If you evaluate customers only on sales volume, you might be misled about which customer is good for your business from a profit viewpoint.
Evaluate each customer using the same basic methodology. The end result is a breakdown, by customer, of profitability.
Factor in Other Variables
In theory you should then focus on growing the most profitable customers, but it's not that simple. Other factors do play a part; a less profitable customer can still provide tangible benefits like:
- Signing long-term contracts and agreements
- Purchasing a variety of products or services
- Providing referrals or enhancing your business image through association
- Enabling entry into growing markets or market segments
Change Your Focus
Once you have determined your most and least profitable customers, then adapt your strategy accordingly.
First, look at your least profitable customers. Do you lose money on any? If you’re like most companies, you probably found at least a few customers that negatively impact profit margins; if so, consider letting them go, raising prices to more profitable levels, or changing how you service them so that you can make a profit on their business. In some cases all you may need to do is find ways to reduce the cost of "additional services" (like non-legitimate support calls), so your total costs for servicing that customer are decreased, and your profits automatically increase without raising prices.
Focus on your most profitable customers. How can you increase the amount of business you do with those customers? Can you sell additional products or services? Should you offer different payment or service terms to encourage greater spending? Most importantly, look closely at what makes this group profitable, and try to apply what you learn to your "average" customers.
Ultimately, you want to change how you deal with customers at each level: least profitable, most profitable and "average." Work hard to convert average customers into more profitable customers and least profitable customers into average customers. No matter what, take great care of your most profitable customers, as they are the lifeblood of your business.