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Assess Profitability of Your Customers

“We love our customers!” Many businesses proclaim this at the bottom of their invoices, in their marketing materials and even on the very walls of their physical locations.

Obviously, every company needs a solid customer or client base to survive. But, to truly thrive, you need to evaluate which customers are reliably contributing to the bottom line and which ones are thinning it out. For those that fall into the latter group, it might be time to show them some tough love.

Tracking the data

Your first step in evaluating customers is calculating, as precisely as possible, how much each one contributes to profitability.

This process will be simple if your sales system tracks individual customer purchases, and your accounting system has good cost accounting or decision support capabilities. Perhaps you have cost data for individual products, but not at the customer level. In this case, you might be able to manually “marry” product-specific purchase history with cost data to determine individual customer value.

Even if you don’t maintain cost data, you can sort the good from the bad by reviewing customer purchase volume and average sale price. Often, such data can be supplemented by general knowledge of the relative profitability of various products. Be sure that sales are net of any returns.

Companies that don’t track individual customers can still analyze customer segments or products. For instance, if the same distributor serves one group of customers, estimate the resources used to support that channel and their associated costs. Or ask individual departments to track employees’ time by customer or product for a specific period.

Be sure to include indirect costs. High marketing, handling, service or billing costs for individual customers or segments of customers can significantly affect their profitability even when they buy high-margin products or services. If you use activity-based costing, your company should already have this information.

Sorting them out

After you’ve assigned profitability levels to each customer or segment of customers, sort them into three groups:

  1. An A group that consists of highly profitable customers whose business you’d like to expand,

  2. A B group made up of customers who aren’t extremely profitable but still positively contribute to the bottom line, and

  3. A C group of customers who are undercutting your profitability.

Members of the C group are customers you likely can’t afford to keep. They’re often overly demanding or even abusive to employees. Some expect special treatment that costs you labor hours or actual dollars. Still others are consistently late paying invoices, which slows your cash flow. Whatever the case may be, they’re firmly in the “no longer profitable” category.

Freeing yourself

It might seem counterintuitive to intentionally let go of customers. However, by showing “C-listers” some tough love — and the door — you’ll free up staff time and resources to better serve groups A and B, as well as to win over promising prospects. Contact us for help evaluating your customers from a cost vs. benefit perspective.

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