When a company takes the time to discover the true profits from its customers it may be in for a shock!
Here are three examples which caused concern for the businesses’ owners and managers:
- a US bank discovered that its all its profits were generated by just 17% of its customers
- a British firm in the speciality chemicals sector generated 50% of its profits from 2% of its customers.
- a European retailer found that only 10% of its customers created 52% of its sales and nearly all its profits.
It is now typical for many companies to be dependent on a fewer number of customers, but there is a danger if the company has not identified these and assumed that because they are their biggest customers, they generate most of the profits.
As customers get bigger and suppliers believe they are more dependent on them, the customer tends to flex their muscles and demand better margins, their own product requirements and the demand for dedicated account management. This all results in extra cost and efforts, which generates a weaker profit margin.
This phenomenon is seen to be exercised on smaller companies by larger customers. There are plenty of examples in which larger customers have demanded more of it smaller sized suppliers, squeezing margins which ultimately lead to financial difficulties and company profits collapsing.
So why does this happen? Well here are five factors that typically confront a supplier:
- customers are more powerful
- the costs of serving a customer are increased in real terms
- fragmentation of the customer base
- a more complex trade channel management
- the arrival of new competition
Customers get more powerful
In many markets customers are spoilt for choice and this can be seen to be the result of three factors:
- Globalisation with more suppliers able to service a market
- Market saturation with greater capacity and customer choice
- Acceleration in product lifecycles
Added to this we have seen an increase in the sophistication of customers which has led to:
- Increasing expectation in levels of service based on the performance of the global brands
- More professional buying functions with more skilled and remunerated staff
- New tools for analysis for ensuring the best quotations
- Better systems for quality assessment and supplier performance
- Creation of specialised and often centralised buying structures
Furthermore, customers have ensured that they find it easy to switch suppliers by ensuring legal contracts allow it and they reduce their dependency on one source.
So as customer choice has expanded and the buying process is strengthened there is increased pressure on supplier’s profit margins.
A Fragmenting Customer Base
It is clear that the market is fragmenting into large customers and smaller ones; and into those that are highly demanding of suppliers. With this added complexity, there is a greater fear that suppliers are engaging with unprofitable customers. We see this in the following ways:
- Polarisation by size in which suppliers are making selling more to a smaller number of customers or “key accounts”.
- Polarisation by need in which customers gave created different ways of working together:
- They may now work in collaboration or even as combatants – but more so it is the customer who often demands the terms and specifications.
- Key accounts are often seen to work in product development – often ensuring their own requirements are to the forefront.
- Larger companies have been seen to bring buying decision under one department – this centralisation in purchasing has also often seen itself in deliveries being sent to one distribution centre.
- The increase in technology in areas of stock and quality control and communications has meant that more real-time reaction is required by suppliers.
How this Leads to More Costs than you may have thought
Traditionally, a business’ costings were directed at departments or products. This has allowed the true cost and therefore the profitability of individual customers to be hidden. However, if we consider the argument I have just made about how the needs of particularly key accounts has become so demanding, we should look at how these characterise themselves in expense.
- An increase in the costs of staff relating to marketing, sales, service and distribution are often the result.
- The costs of Customer Relationship Management (CRM) systems has increased and there are more requirements to ensure these systems are flexible and robust for the ever-increasing demands of customers.
- There is an increase in costs as customers demand solutions rather than products. They often require implementation teams to on-board products and an increase in pressure on the suppliers to deliver. There is an increased risk if the supplier starts making any of the following mistakes:
- Misunderstanding the customer’s requirements
- Over-promising what can be delivered
- They discover they have provided the wrong solution to the customer’s needs
- They discover the customer is wrong for them
- There has been an increased in the propensity for unhappy customers to resort to litigation and there are even examples of corruption – both can result in financial expense and management distraction.
Getting Cleverer with Your Customer Costs
So how are you ensuring that you know what the costs of your customers? Do you see if your customers make a positive contribution to your company’s overheads?
A survey of over 200 major UK firms, 74 % of their sales directors claimed that serving the needs of five keys accounts was their objective for the next five years. This would mean that they believe the profit of their business is very concentrated.
I think the biggest issue facing every business is to ensure that this concentration of effort is in the right place to maximise the business profits. Fortunately, with good accounting software there is the opportunity to more efficiently manage the profit opportunities within your customer base. If you do this correctly, you will open new opportunities to new sources of profit. It is an exciting time to effectively manage your customer base and bring real business success.