Chris Maloney – Advisory Partner
A business must have customers to succeed, right? Well yes, of course, but business owners should be asking whether these are the right type of customer. This is a question that should certainly go beyond the obvious “do they pay on time?” and the focus should be on further criteria in order to define ‘what makes an ideal customer’ in order to ultimately drive business value.
However, before looking at one’s customer base, a prerequisite is that a business owner should be fully aware of the true profitability of each product or service line. It is critical that as well as all direct and indirect costs being taken into account, the cost of management time should also also be considered when establishing gross profit as these can alter the profit profile. Assuming a business has good systems and procedures in place, much of this management information should be readily accessible to a business owner (given the number of cloud based accounting software solutions and additional apps available),; if not I’d strongly recommend a read of Tim Dunn’s ‘Is your profit data Misleading you’ article.
Once true profitability is known a business owner can then embark on a Customer Profiling exercise.
What is Customer Profiling?
Essentially Customer Profiling is an exercise carried out on a timely basis at the beginning of a financial year, by reflecting on the previous period to rank customers. The ranking criteria – that will differ depending on the business – is likely to include the following criteria:
- Pays on time
- Clear on deliverables
- Incurs minimal unproductive management time
- Good referrer of new business
- High growth potential
Once the criteria has been agreed by the business owner, directors or board, each customer should be rated, say, out of 10 for each criteria, perhaps giving additional weighting to the important aspect profitability, say out of 20.
Following the assessment of each customer against each ranking criteria, the overall total per customer should then be categorised into quantiles e.g. A, B, C and D customers where ‘A’ is the best and ‘D’ the worst.
Having given each customer a grade, it is important for a business owner to establish the likelihood of any rating increase in order to fully assess the long-term value of the client. It is important to recognise however that it will be unlikely that a ‘D’ customer could jump up to an ‘A’ or ‘B’.
So, how do you assess whether a customer rating could be promoted?
Well the business owner may want to assess whether the following actions have been carried out:
- Renegotiation of the customer’s sale price
- Clarification of credit terms
- Making a client aware of historic scope creep
- Asking for more business, referrals, testimonials etc.
Once the profiling exercise is complete, a decision then needs to be made as to which customers to the business should work with now and target in the future. Will it be your ‘As’ and ‘Bs’, or will you be bold and just choose your ‘As’?
Tried and tested Customer Profiling
A carpentry business that we act for carried out this exercise and decided to ONLY continue to work with the top 20% of their clients, which resulted in an increase in profitability, allowing the owner more time to focus on Strategy, to achieve their Vision, and ultimately increasing BUSINESS VALUE.
Once your customer profiling exercise is complete, it will be essential to carry out a three way integrated forecasting exercise. This will allow a business owner to assess a variety of ‘what if’ scenarios according to your revised customer base, to fully appreciate the likely impact to the company’s profitability. In theory , this should now be more straight forward due to having a more reliable customer base.
The forecast should show a number of positive changes from having a leaner customer base. Look out for:
1 – Less pressure on working capital requirements
This is due to a reduction in debtor days, as the business will no longer have slow paying customers and;
2 – cash not being tied up in stock held for customer who do not achieve the ‘ideal’ profile.
Knowing what ‘new business’ customer to attract, will inevitably lead to a greater focused marketing strategy, rather than perhaps previously having a scattergun approach, whilst of course ensuring maximum efforts are made to retain your existing ‘ideal customer’.