Ask entrepreneurs to identify their biggest clients, and they’ll likely be able to rhyme off the names with ease. But ask the same business owners who their most profitable customers are, and out come the spreadsheets.
Too many companies focus on revenue over profitability according to Anne C. Graham, Managing Director of The Legendary Value Institute and author of the new book Profit in Plain Sight: The Proven Leadership Path to Passion, Profit and Growth. “It’s profit that pays our bills and allows us to continue investing in our business so that we can continue to serve our customers,” she observes.
Your most valuable customers are not the ones who bill the most, but the ones where your margins are best. Here’s how you can identify those profitable customers and make more money from everyone on your client list.
Don’t do the math
Top-line revenue is relatively easy to calculate, as is overall profit, but figuring out which of your customers are earning you more than they cost can take a lot of time and resources. Graham’s system for calculating profitability-per-customer relies on your day-to-day interactions with customers rather than your accounting system. Take payment terms, for example. “Which customer is more profitable for you: someone you have to chase, finance, then wait 60–120 days for your money, or someone who pays on time?” asks Graham. “The one who pays on time.”
This unscientific approach may strike results-oriented entrepreneurs as odd, but Graham says it’s much more efficient and effective than number-crunching. “What we’re looking for is good enough for good decision-making,” she says. “We’re not looking for exact.”
Once you’ve got a sense of how lucrative each of your customers is, slot them into the profitability diamond. Graham says it’s typically an 20-60-20 split: the top fifth of customers are profitable, the middle third are break-even, and the bottom fifth are what she calls “vampire customers,” who cost more than they pay.
Start at the bottom
The biggest gains are to be found in the unprofitable tier. Graham says money-losing customers typically cost up to 100% of your existing profits, meaning that restoring them to break-even could double your bottom line. But don’t just pick up the phone and start cancelling your least lucrative contracts. “When you look at those unprofitable customers, in five cases out of six, it’s a self-inflicted wound by the company,” says Graham.
Sometimes all it takes is a small change to get things back on track. Graham gives the example of an Atlanta company she worked with recently. A 23-year-old clerk sitting in one of the sessions took it upon herself to reach out to her company’s unprofitable customers. “She started picking up the phone the next day, and she wasn’t doing collection calls on her customers,” says Graham. “She was basically saying, ‘We love doing business with you. We know that you love doing business with us. Here’s something that’s not working. How do we actually get this back on track?’”
The clerk found that in one case, the customer had been paying their invoices late because they were being sent to someone who no longer worked at the client firm—a dead email account. “People don’t necessarily know how to change those numbers, but they know how to change behaviours,” notes Graham. “In this case, it was just getting the invoice to the right person and that was a good customer who was happy to pay on time.”
Over-delivering is unsustainable
Your big clients are still important, of course—they provide sales volume. But every mistake or unprofitable decision you make about a large customer is is magnified by the size of your business with them. “If you’re losing money on all that volume, you are not going to stay in business,” notes Graham.
Graham cites the case of an HR placement firm in Vancouver. “They deal with a huge multinational company, and they were supposed to be providing three candidates for each job,” she explains. “Because these were nice people and they wanted to really take care of that big customer, they were providing six candidates.” That resulted in the relationship being very unprofitable for the HR company, not because the customer was bad but because the firm was over-servicing them.
It’s a common trap that SMEs fall into when working with big companies, according to Graham. “Those are the ones we tend to bend over backwards for, and sometimes it’s not even appreciated,” she says. “So it’s costing us a bundle and the customer doesn’t even know it.”
Going above and beyond will only get you so far before it turns into a liability. Remember, there’s nothing wrong with sticking to the terms of your contract.
Money on the table
Once you’ve got the bottom end of your profitability diamond sorted out, there’s plenty of money to be made in the middle. Most break-even customers can be made more lucrative, often simply by doing more business with them. “I have managed and led many sales teams, and everyone is always looking for what I call the thrill of the kill—the fresh meat, the new customer,” admits Graham. “They ignore all of the potential that is there in their existing customers.”
Start by understanding where you could be doing more business with your clients. Graham gives the example of a safety equipment company. “Their CEO started talking to some of their middle-zone customers and found that she was the smallest supplier to her biggest customers,” Graham explains. “All their business was going to other suppliers because they didn’t even know a lot of the products that she already had.” Instead of pitching new products, the company’s sales team had essentially turned into order-takers.
Not every customer is a source of new profit, however. Some customers always spread their business across several suppliers. “Technically you could be doing more business with them, but you will never end up doing more business with them, because it’s in their best interest to minimize their risk by having a lot of suppliers in case there’s ever a problem with one,” says Graham, citing the automotive industry as a common example of this kind of supply chain.
When to break ties
Of course, not every relationship is salvageable, and some customers will simply never be profitable. It’s appropriate to fire a client if they’re never going to pay on time, are incredibly difficult to deal with, or cost you a fortune according to Graham.
It’s also worth identifying clients who are simply a bad match for your business. Graham cites the example of a Vancouver food service delivery company that won a contract to supply Starbucks with breads and pastries. But the company’s typical customers were massive supermarket chains like Safeway and Loblaws. “Think of the size of the tractor-trailers that back up to those major grocery stores,” instructs Graham. “And then picture your local Starbucks and the narrow back-alley that is usually behind it.”
While the Starbucks account provided huge volume, it was an equally large mismatch. “They had to change their entire delivery system, buy a whole fleet of new vehicles, and hire new drivers—all to service that account,” says Graham. “In this case, firing Starbucks is probably the best thing to do because they probably should never have had them on board in the first place.”
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Do you know who your most profitable clients are? Do you agree with Graham? Let us know using the comments section below.