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Part of the problem is that without some sophisticated and
time-consuming investigation, there is no way to know exactly how much
better the good customers are than the bad ones. Without such
information, the easiest path to follow is to give every customer the
same pricing and service package. Such an approach often has very
negative financial consequences.
This article will explore customer account management for AVDA members.
It will do so from two perspectives:
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The Profitability Difference—It
will provide insights into how much profit the typical AVDA member
makes on different customers.
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Account Planning—This will
provide a basis for taking specific action to generate the maximum
profits from the accounts being serviced.
The Profitability Difference
A specific customer profitability analysis project has never been
conducted among AVDA members. However, similar groups of distributors
have conducted such an analysis. They all came to the same
conclusion—there are a few very profitable customers and a lot of
marginal ones. This conclusion is demonstrated in Exhibit 1 which
applies the research from other industries to AVDA economics.
According to the PROFIT Report, the
typical AVDA member has annual sales of $150,000,000 and a pre-tax
profit of $4,500,000 or 3.0% of sales. The report also indicates that
the typical firm generates $20,000 of revenue per customer. The firm
with $150,000,000 in sales would thus service 7,500 accounts. Exhibit 1
suggests these figures hide a lot of variation.
The exhibit divides the customers into four groups. The A customers are
the most profitable ones, while the D customers are the least
profitable. It is important to note that these breakouts are not based
upon sales, but rather upon the dollar profits the accounts generate.
This reflects the margins generated on the accounts less the costs of
selling, servicing and supporting the customers.
As can be seen, for the typical firm there are about 1,125 customers, or
15% of the total that are in the A (high profit) category. The critical
factor is that these few accounts generate aggregate profits that are
equal to the profits of the entire firm. It is a startling
conclusion—15% of the customers provide 100% of the profits.
At the other end of the spectrum, there are a lot of D accounts; around
2,625 for a typical firm. These accounts collectively lose money for the
distributor and not in a minor way. The combined losses on these
accounts amount to $2,025,000 which equals 45% of the total profit
generated by the entire firm.
The theoretical implications of Exhibit 1 are obvious. If the firm
eliminated 2,625 customers, its profits would increase by $2,025,000 and
the company would not have to do nearly as much work as it now does.
Turning theory into a profit reality gets a little trickier, however.
Account Planning
The challenge is to take the overview information from Exhibit 1 and
turn it into action. This challenge is made extra difficult when there
is no specific information on which customers actually fall into the A
through D categories. While the challenges are daunting, they are not
impossible to overcome.
Since there are something like 2,625 unprofitable accounts, identifying
at least some of them should not be a challenge. Even without a customer
analysis system it is usually easy to identify the customers who are
probably unprofitable. These customers tend to have a couple of key
characteristics. First, their gross margins are likely to be lower than
other customers. Second, they increase the workload of the firm because
they generate a lot of small orders, deliveries and returned goods.
The real undertaking in any customer analysis effort is taking action
once the problem accounts have been found. In general terms,
unprofitable customers will require one of two different actions—fire
‘em or fix ‘em. In practice, what is needed is a very little of the
first action and a lot of the second.
The ones that should be fired are almost obvious. They tend to engage in
a wide range of behavior that drives profit away. They often cherry pick
from a number of different suppliers, they are aggressive price
negotiators, they expect a lot of additional services from the firm and
they tend to be error prone, with lots of returned goods, questions over
billing and the like.
The concept of firing customers has become fashionable in recent years.
However, it should be approached with caution. In most businesses, there
are only about one to two percent of the accounts that should be fired.
Taking the typical AVDA member again, this would translate into at most
150 accounts.
Finding the very few customers to fire is not a difficult task. The much
more difficult undertaking is working with the customers who are
unprofitable, but who could be made profitable if their behavior could
be changed slightly. It requires a perspective that customers can be
“managed” in a way that improves profitability for the customer as well
as the AVDA distributor.
Such managing requires discipline in terms of price concessions on the
margin side. It also requires working with the customer to develop more
meaningful buying patterns on the expense side. Customers who place lots
of small orders are not only increasing the costs of the distributor,
they are increasing their own costs. There is a clear opportunity for
mutual benefit in changing buying patterns. When combined with margin
improvements the opportunity to increase profits on customers is
enormous.
Moving Forward
Customers are the very reason for every organization’s existence.
However, oftentimes customers buy in ways that make it difficult, if not
impossible, to produce a profit in servicing them. Every firm needs to
make a concerted effort to identify those problem accounts and take
direct action to improve the profitability in servicing them. The
potential rewards in doing so are great. The firm is not only doing
itself a favor, but also helping customers buy in a way that increases
their profits as well.
About the Author: Dr. Albert D. Bates is founder and president of
Profit Planning Group, a distribution research firm headquartered in
Boulder, Colorado.
©2006 Profit Planning Group. AVDA has unlimited duplication rights for
this manuscript. Further, members may duplicate this report for their
internal use in any way desired. Duplication by any other organization
in any manner is strictly prohibited.
A
Managerial Sidebar on Firing Unprofitable Customers
Most firms do not want to even think about firing a customer. It doesn’t
make any difference how much money is being lost on the account. The
thought of consciously suggesting a customer go away is simply too
negative.
Part of the problem is the somewhat futile hope that some day the
relationship will get better. There are also the very real issues of
whether the account will merge with a good account, will change
management or something else will happen to make the account more
desirable in the future.
Because of these concerns, most firms take the approach of letting
customers fire themselves. This involves a conscious change in the
pricing matrix for these customers. By definition, customers are
unprofitable because the gross margin earned on the account does not
cover the costs of servicing the account. Reducing services is a
somewhat uncertain process, so increasing prices provides the “easier”
of the two options for covering expenses.
Most firms simply adjust prices upward in moderate, but measurable,
increments systematically over time. The price increases should be
properly transmitted to the account as a part of normal operations. At
some point the customer either seeks an alternative supplier or becomes
profitable for the distributor.
A number of firms have found that very few problem accounts actually do
fire themselves. They continue to value the services being received from
the distributor and accept the higher prices. They may shift an
important sector of their purchases to other suppliers, but they do not
entirely terminate the relationship.
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