Capital Markets

Playing Favorites

It's tempting to feel grateful for every customer you have. You should fight that feeling.
Josh HyattJanuary 1, 2009

Ready to meet the new Chief Profitability Officer? OK, then, grab a mirror: you’re it.

No need to have new business cards printed, you’re still the CFO as well. But you now have additional duties in line with the company’s new recession-fighting strategy: use profitable customers to drive corporate value. The concept has been around for some time, but it has acquired a fresh urgency in today’s climate. By pinpointing your profitable customers and looking for more ways to serve them, you may be able to coax new life into the bottom line.

Once those favored customers are defined and divided into homogeneous groups, CFOs will be expected to track their value like any other asset on the balance sheet. By overlaying certain metrics — such as buying needs, cost to serve, and strategic value — management can gain insight into exactly which group of users it should be courting and keeping. It might aim its promotions toward upper-middle-class women, for instance, or younger married males with a fondness for fancy gadgets. It won’t be going after everybody anymore; value-crushing customers, who just buy what’s on sale, won’t get any special attention at all. “In a time of limited resources, management has a desperate need to figure out its priorities,” says Larry Selden. “Now is the time to segment your customers.”

Selden, professor emeritus at Columbia University and co-author of Angel Customers and Demon Customers, contends that the bottom 20 percent of customers can drain profits by at least 80 percent, while the top 20 percent can generate 150 percent of a company’s profit. So why not study that upper crust, delicately breaking it into subsegments that share the same needs? Categorizing customers by demographics or geography or product purchases, as many companies do, doesn’t give managers a clue as to where the high-opportunity needs are lurking.

In the long run, precision targeting will generate profits far in excess of any incremental cost. Unfortunately, that won’t be the case in the near term, because such intensive analysis is time-consuming and expensive. Furthermore, there are likely to be expenses associated with reorganizing operations and training front-line employees in how to look at the data so that they know, right on the spot, that the customer in front of them would be receptive about an extended warranty. As much as spending money on the analysis may irk CFOs, Selden reasons that “now is the time to do it. Expectations on earnings are low, so in the short term it’s not going to make much difference if you spend the money on customer segmentation.”

That’s probably a much more engaging task than what most CFOs have their staffs doing now — monitoring the cash cycle and modeling what-if scenarios to make sure there’s enough working capital on hand. That can be pretty routine work. If days sales outstanding is stretching out — the average DSO increased from 39.7 to 41 between 2006 and 2007, according to consulting firm REL — it’s time to sic corporate counsel on the worst offenders. If your revenue model presumes that 10 percent of customers will pay late, it’s crucial to work the spreadsheet, updating projections to account for the fact that that number may be inching toward 20 percent. But to move the company beyond mere survival, what they should do, says Selden, is “change the company from being product-centric to being customer-centric. In an economy where there are real cost constraints, you can’t serve everybody to the same degree.”

As companies realize this, “the most capable customers and the most capable suppliers will get together and get bigger and better,” predicts Jonathan Byrnes, a consultant and a senior lecturer at Massachusetts Institute of Technology. Every CFO, says Byrnes, should start acting as “the chief profitability officer, in charge of making more money from existing customers without adding any costly initiatives.”

The Un-chosen

At most companies, about 30 percent of customers aren’t profitable — and two-thirds of those aren’t ever going to be, according to Byrnes. Some have been plied with discount upon discount over the years, surrendered by quota-driven salespeople and approved by sales managers whose compensation depended on volume. But armed with further insight into your customers, “you don’t have to discount, because you know you have something they value,” says Selden.

Such selectivity means that, like bouncers at glitzy nightspots, executives will almost certainly have to “fire customers,” as management gurus put it. “With less business to go around, a company has got to know where it can contribute the most value,” says Barbara Bund, author of The Outside-In Corporation. “That’s where its future growth is going to come from.”

Splitting with unprofitable customers is far less dramatic than, say, any Hollywood bust-up. It may simply entail having a frank conversation about what you can and can’t do for them. Is there a more cost-effective way to handle their account? Maybe replacing customized items with a standardized version, or asking them to rely on Web-based support, or helping smooth out erratic ordering patterns.

By Selden’s estimate, it takes about six months to produce a customer-profitability analysis and segment the results into a portfolio of needs-based customers. Using software analytics, Selden sifts through cost data, records of individual transactions, and customer demographics. Selden’s consulting firm, Selden and Associates, has developed a process to perform this function — a much more comprehensive approach than CRM software systems. He first ranks money-making customers on a spectrum from least to most profitable. He splits that list into subgroups of customers that share certain needs based on their buying patterns, behaviors, or other information. The company also talks with customers.

Once a company is armed with such information, it’s in a good position to calmly explain to certain customers why it can’t continue serving them in the same way. But rather than issuing an ultimatum, it can indulge in a dialogue with unprofitable customers, showing them why prices have to go up, but also offering suggestions as to how they can cut corners. For instance, customers often request overnight delivery because they don’t trust their suppliers. Why not settle for a slower, cheaper route? Retailers can discourage profit-puncturing customers by cutting off their coupon supply, or adding a restocking fee on returned merchandise. These moves may foster a “you can’t fire me, I quit” attitude among unprofitable customers.

Your company’s newfound mission — the one that will serve as a competitive advantage, long after the word bailout has returned to its maritime roots — is to devote all of your resources to fulfilling and expanding your relationship with your profitable accounts. For certain retailers, that means crafting bundles of products that will be both appealing to customers and profitable — promoting an entire outfit, for instance, rather than just one discounted sweater. At Best Buy, that meant trying to change the behavior of roughly one million customers it had identified as unprofitable. The retailer also made it harder for the small number of aisle-wandering abusers to, say, return merchandise after applying for the rebate and then buy it back at the lower price that gets slapped on returned merchandise. The outcome: “Best Buy is doing better than all of the pure-play consumer-electronics companies,” notes Selden. By stark comparison, rival Circuit City has filed for bankruptcy protection and is closing nearly 200 stores; Tweeter, which manages about 100 stores, is shutting down. “Best Buy is well positioned,” notes Selden. “It will be getting an increasing share of the existing market.”

From Customer to Partner

As you get closer to your profitable customers, the relationship may take one more step: collaboration. By helping those customers increase their profitability — working on long-term planning, say, or winnowing the supply chain — you can become about as close to indispensable as possible. “Companies exist within four walls,” says Byrnes. “What a company should do is create a bigger box around the business by moving the boundaries.” Perhaps in a variation of that spirit, Google and Procter & Gamble began swapping employees last year, with two detergent-brand managers working inside the Googleplex and a pair of Google employees shifting to Cincinnati. Presumably, P&G wanted to know more about online marketing, while Google soaked up smarts about customer research.

The flow of information between companies can lead not only to increased business between them, but also to wholly new opportunities. Until recently, Corporate Transportation Group (CTG), a “black” car service based in Brooklyn, counted among its customers both Bear Stearns and Lehman Brothers. Last year, the company began selling its proprietary software to similar services, which “gets us inside some interesting places,” says CFO Vadim Zilberman. “We realize things that are done differently.” As for his own customers, “they love to be visited as much as possible, not just during negotiating season,” he adds.

Last year, while visiting a bank customer, a CTG account manager picked up word of a new building going up in midtown Manhattan. CTG became the exclusive supplier to the building’s eventual tenants by creating a customized dispatcher-free platform.

The ultimate alliance is what Byrnes calls “customer operating partnerships,” which can easily boost business by at least 25 percent. In these pacts, vendors and their valued customers braid the separate strands of their supply chains together. The customer isn’t just strategically positioned to pick up additional business; operating deep inside the business, it has now built a barrier to entry for potential rivals. “It makes it very hard to displace,” says Byrnes. The companies naturally broaden their contact with one another. So, for instance, instead of dealing exclusively with a price-driven purchasing agent, the supplier’s management team will interact with higher-level executives, who tend to be oriented more toward value. They are likely to be more receptive when you pitch them on the idea of crowning you “a master supplier” and offer to manage their inventory. By streamlining the inbound product flow and consolidating their billing, you’ll save them money. Your own profits will fatten as you find opportunities to make the supply chain more efficient, cutting out any redundant or disjointed steps.

The idea may take some time to gain traction. One pasta maker wanted to take over a supermarket chain’s ordering process. Sensing reluctance, the pasta company came up with a plan designed to reassure them: We’ll park a truck full of pasta in your lot, the supplier said, and anytime we don’t deliver you can take what you need — for free. The truck wasn’t there for long. Says Byrnes: “You want to find a way to extend your business far into their operations for your mutual benefit. You’ll grow together.”

Providing close-to-the-market data can also create a bond. In consumer electronics — or, for that matter, any product with a short life-cycle — a supplier can be a valuable source of information about when the item’s profits have begun eroding, suggesting that shipping should be winding down. Such data is more valuable than ever, given the pressures on margins. “Customers are going to be receptive to help now because they are under so much financial pressure,” says Byrnes. But before you shift any resources in their direction, try to look beyond the data, assessing their overall strategy and sizing up their leadership team. They may be profitable for you now, but what are their prospects? “In this economy, we are being very cautious about who we develop relationships with,” says Linda Booker, CFO of IDI, a $2 billion commercial-real-estate developer in Atlanta. “Before we work with anyone, we’re paying utmost attention to their balance sheet. We ask them about their relationship with their bank, what debt is maturing over the next five years; we explore their ability to refinance. We’re extra-careful.”

Relationships Take Work

CFOs have to be extra-careful too, monitoring the performance of the company’s “portfolio of customers” on a regular basis, says Selden. If that sounds like a lot of work — well, it is. “This is not a trivial undertaking,” warns Selden. “But the fact that it’s really, really hard is great. Segmentation becomes a competitive weapon.” It just takes time. “This is a fundamental rethinking of a business,” says David Reibstein, a professor of marketing at the University of Pennsylvania’s Wharton School of Business. “We’re going to see more companies investing in this, finding out the value of their customers and paying more attention to some of them.” The ultimate goal: to have more value-laden relationships with fewer customers. Not that any company will execute with 100 percent accuracy. “The truth is,” says Bund, “you never know as much as you want to know.”

But you may soon come to know a lot more than your competitors do.

Josh Hyatt is a contributing editor of CFO.