Do You Have A Customer Selection Problem?

They aren’t all the same. For better—and long-term—profitability, make sure you’re going after the customers you need today.

Account selection is one of the most important processes in a company. It is the front-wheel drive that pulls a company through its market. You have a lot of discretion in choosing customers, but once you have engaged a set of customers, your account management options are much more limited.

The customer deal desk is your key point of leverage. It is where you determine with whom you will engage, and the contractual terms that will frame your relationship with both prospective and renewing customers. It makes all the difference in your success.

For example, one well-regarded Midwestern retailer did a study that found that its high-profit customers produced $750 million in revenues and $150 million in profits, while its money-losing and low-profit customers produced $875 million in revenues with a shocking $75 million in losses. This retailer had an account selection problem.

To be successful, the deal desk team must answer key questions like:

• Does this potential customer fit our strategic and competitive direction?

• What price and non-price variables (e.g. product mix, order pattern, service offerings) are the most important determinants of our profitability serving this potential customer?

• How do we set these contract terms, and what guardrails or constraints do we need to include in the contract to make this a profitable customer?

• What changes do we need to make to our renewing customers’ price and non-price contract terms to ensure that they will be profitable?

• How can we profile our high-profit customers so our “hunter” sales reps know who to target?

Assess customer fit

A good customer is both profitable and moves the company’s strategy forward. This raises a very important question: are all profits desirable?

In the past mass market era, markets were relatively homogeneous, and all revenues and profits were desirable. The key to success was achieving economies of scale, which meant that the more products a company sold, the lower the cost of each product. This created a virtuous cycle because with lower product costs, a company could reduce its product prices, which in turn further increased revenue.

Today, markets are fragmented. As Amazon and the other digital giants provide information-rich products at arm’s length to small customers, incumbent firms increasingly look to defensible, higher-service customers. The key to success today is flexibility and responsiveness.

This means that pursuing smaller customers that logically would be better served by a digital giant might for a time produce profits—but these profits are most often written in disappearing ink. The opportunity cost of pursuing and serving customers in this evaporating segment is that it keeps a company from focusing its business development efforts on the customers that will provide lasting profit growth.

In today’s rapidly changing markets, your deal desk has to assess both a prospective customer’s near-term profitability, and its likely lifetime value. In our turbulent markets, customers have to offer long-term profit growth.

The case of Custom Research illustrates this imperative. Custom Research is a market research firm. For a number of years, it grew its revenues to achieve critical mass as a major industry player. More recently, however, its revenue kept growing but its profits stagnated.

The problem was that the company took any business that it could win. When the company examined each account closely, it found that the long tail of small accounts was contributing some profits, but most did not have the potential for sustained profit growth.

In fact, because it took significant time to develop and learn about a new account, these small customers were taking a huge proportion of account managers’ time, which prevented them from further penetrating their high-potential accounts with customized solutions. The minor profit contribution of the small accounts was actually creating a large opportunity cost because they took time away from growing the company’s high-profit business.

The solution was to institute a minimum account size: new accounts had to have the potential to grow to certain benchmark revenues (and profits) not only in the first year, but also in the subsequent years. The company’s revenue and profits skyrocketed.

In other companies, many large customers have a cost to serve that is excessive, generating losses—even with market-rate pricing.

Profile your profit segments

Enterprise Profit Management (EPM) provides the basis for clustering your customers into profit segments and setting contract terms that ensure customer profitability. It creates a full, all-in P&L for every transaction (every product bought by every customer every time) and uses a sophisticated data structure to combine and recombine these transactions to show the profitability of every nook and cranny of a company.

Over years of experience with EPM, we have found that virtually all companies have a characteristic pattern of profit segmentation:

• Profit Peak customers—typically about 20% of the customers generate 150% of a company’s profits;

• Profit Drain customers—typically about 30% of the customers erode about 50% of these profits; and

• Profit Desert customers—typically the remainder of the customers produce minimal profit but consume about 50% of a company’s resources.

The objective of the customer deal desk is to bring as many Profit Peak customers into the company as possible, and to frame contracts that will ensure their long-term profitability. It is equally important that they be able to recognize and avoid customers that will become Profit Drains or Profit Deserts.

Develop conditional pricing

Most contracting processes focus on price, but this is only one variable in contract profitability—and often it is not the most important variable. In fact, in our experience most unprofitable customers do not have below-market prices, rather they have unmeasured sales and operational costs that generate the red ink.

For example, a few years ago, we worked with a major truckload carrier. The company had managed its profitability primarily by trying to maximize the revenue from its headhauls (outbound loads). After that, they lumped its backhauls (return or repositioning loads) together as a partial offset in order to calculate the company’s overall profits.

When we used Enterprise Profit Management’s transaction-level profit analysis to create an effective profit management system, we linked each headhaul with its associated backhaul or repositioning cost.

The company’s managers were amazed to find that the most important profit variable was the lead time the trucking company had in booking the outbound load. If they could book a load a week or so before the pick-up date, they could get a good price for the backhaul load. But if they had only a day or two between booking the load and picking it up, they could only get very low prices for the backhaul in the spot market.

In fact, the extra four or five days lead time provided profits that were equivalent to a 10% headhaul price increase. Fortunately, most customers could easily predict their trucking needs a week or more in advance, which greatly increased the trucking company’s profitability.

In other companies, we have seen similar unmeasured operational costs in areas like order frequency and expediting cost, as well as unmeasured product and sales costs stemming from areas like customer product mix.

An effective customer deal desk uses this granular information to set contract terms that not only cover price, but also the many critical but unmanaged cost-to-serve elements that can determine whether a customer will be a Profit Peak or Profit Drain.

The first step in this process is to develop a “peer group” of similar current customers, and array them by profitability. The second step is to identify the key variables that make them profitable or unprofitable. Based on this granular information, the deal desk team can project the all-in profitability of an RFP, and set the contract’s terms, guardrails and constraints to ensure that the customer will be profitable. This process is effective for renewing customers as well.

We call this process “conditional pricing.” Conditional pricing enables the customer deal desk team to structure every clause of a contract (for prospective and renewing customers) to ensure that it will be profitable—in most cases, even if the price is at or under market.

The EPM SaaS software accommodates scenarios that managers can use to test the sensitivity of every revenue and cost variable, which enables them to set each variable to ensure customer profitability.

Hunt for the right customers

Enterprise Profit Management makes it easy to profile a company’s Profit Peak customers. This profile includes not only revenue potential, but importantly, real profit potential based on a customer’s likely willingness to agree to conditional pricing terms.

For example, returning to the trucking company vignette, a prospective customer might have a policy of shipping to its customers within 24 hours of order receipt. The EPM Profit Peak account profile would flag this policy as a likely cause of unchangeably high backhaul costs. Even if the headhaul price is above market, this probably would cause chronic losses. It would be very difficult, if not impossible, to change this customer’s policy and move the customer into profitability.

If, on the other hand, a prospective customer is shipping product to meet its customers’ pre-planned production schedules, it probably would have the ability to book loads a week or more in advance. It would be reasonable and important to include this provision in the customer’s contract—or even offer a modest discount for pre-planned loads.

The objective of this process is to give sales “hunters” a complete profile of what to look for in prospective customers. This contrasts strongly with the all-to-often situation in which sales “hunters” are compensated based on near-term customer revenues.

Develop an effective deal desk team

The customer deal desk should be managed by a small, elite group reporting to the Chief Sales Officer and the CFO, as it is essentially creating and managing both the company’s sales and profit strategies. The group should include managers from both Sales and Finance.

By blending these two critical perspectives, the customer deal desk team will enable its company to meet its ultimate objective of long-term profitable growth.

Jonathan Byrnes is a Senior Lecturer at MIT, and Founding Chairman of Profit Isle. John Wass is CEO of Profit Isle, a profit acceleration SaaS company with proprietary analytics that have produced sustained year-on-year profit increases on tens of billions of dollars of client revenues. Jonathan and John are co-authors of the forthcoming McGraw Hill book, ”Choose your Customers: How to Compete Against the Digital Giants and Thrive”.