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 WRymer@kmco.com or (215) 441-4600.