What do your customers cost you? If
your business mirrors the 80-20 rule,
where 80 percent of your business comes from 20 percent of your customer
base, is that other 80 percent of customers
worth keeping?
As business owners focus on top-line
growth, they often lose sight of the profitability each customer brings to their business. A
few service-intensive, time-consuming customers can chip away total company profits
if you aren’t careful, says William Rymer,
director of the Business Advisory Group at
Kreischer Miller, Horsham, Pa.
“A lot of organizations lose sight of the true
cost when they are expanding their product
lines or when they expand their offerings to
meet customer requests,” he says.
Smart Business learned more from Rymer
about analyzing whether customers are profit bearers or burdens.
How do companies fall into a cycle of unprofitable revenue?
It happens innocently, usually to please a
significant customer or in an effort to expand
products or services in the marketplace. Say
a big-time customer asks you to package a
product differently. He wants your widgets in
six-packs, another customer orders them in
twos, and a third customer wants a case of
24. You must alter your product line slightly,
and you’ll need to create new packaging for
each request. This essentially means three
different products, tripling the complexity of
your labor and production line. You might
have figured that the only added cost is the
differential in raw packaging costs. But this
type of expansion also requires an increase in
inventory levels to support those customers.
Over time, you whittle away the profit margin
you once made with those customers.
The same scenario can play out in the service sector. You create a new branch office to
cater to a large client in a new territory. You
add a new service to the mix at the request of
a customer, which leads to additional labor
costs and overhead expenses, such as rent. In
a quest to please, you destroy profit and increase risk by expanding your cost structure.
The question you must ask yourself is: Are
you recouping the incurred costs of production and other back-end expenses that add up as you tweak, invent and roll out products
and services to please those customers?
How can management limit the liability any
given customer puts on a company?
The deeper the relationships you have with
your customer base, the less likely you will
be replaced by competition. So it makes
sense to want to cater to customers. But you
must understand the cost behind the service
or products you offer them. You need to track
profitability by customer and product line.
You need to capture back-end costs, whether
shipping procedures, customer service or
production. Do you have systems in place to
measure all of your costs? If so, when a customer requests something special, you will
know what areas of the business will be
more stressed and how much it will truly cost
you to please this customer. Then, ask yourself how important this customer is in the
overall picture of your business.
How can a business owner use this information to ‘find money’ that can be reinvested?
Separate your customer list and your products or services. In what products or services do you want to invest? Clearly, you want to
go after the ones that provide the highest
returns, especially if you have limited access
to capital. And with today’s banking environment and tight credit markets, access to capital is an issue for most businesses. Your goal
is to maximize your investment in the products and services — and customers — that
deliver the highest return on investment.
Here’s how that can play out for your business. If you eliminate less profitable products, services and customers — skim off the
bottom 20 percent — you free up dollars to
invest in higher-margin business. This
decreases exposure to excess inventory and
allows you to invest more funds into the right
parts of your business. By trimming ‘flat’ or
cost-prohibitive products, services and customers, you essentially ‘find money’ within
the organization to invest in growth without
having to approach external sources. Also,
it’s important to note that most banks will ask
if you raised capital within your organization
before you approached them for funding.
How else can a business look for capital
within the organization?
Evaluate your accounts receivables to
determine customers’ pay habits. If a customer pays you 75 days after invoicing, you
are essentially extending a line of credit and
tying up capital that could be reinvested in
the business. Also, consider your overhead
costs. Can each branch or facility function
independently as a successful profit center
without leaching profits from the overall
business? If the answer is no, it’s time to
reconsider your multilocation infrastructure.
Lastly, review your vendor relationships. Are
you able to obtain longer payment terms that
help to retain cash within your company?
Put everything else on the table for review.
Ask yourself: How can we run more efficiently? Can we invest less capital if we have
fewer manufacturing assets? If we reduce
inventory, can we invest more into core
products? The process of evaluating customers, products and services and rating
their profitability in your overall business is
ongoing.
WILLIAM RYMER is director of the Business Advisory Group at Kreischer Miller, Horsham, Pa. Reach him at [email protected] or
(215) 441-4600.
