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[Note: the following post concludes with a challenge. I hope you’ll consider proposing a solution!]

I can’t stand it anymore.

If I hear one more (otherwise intelligent) person mention the concept of a ‘profitable customer’, I’m going to scream!

The concept of a ‘profitable customer’ is as big a nonsense as that of a ‘profitable sale’, or a ‘profitable product’.

Customers — and I hope you don’t find this revelation too shocking — are NEVER profitable. Any more than sales are. Or products.

Only businesses make profits. Customers don’t. Sales don’t. And products don’t.

The implicit suggestion that the profitability of a business is equal to the sum of customer profits is too silly for words . . . and I’m happy to explain why (the same logic applies equally to sales and products).

Let’s see if we can unravel the logic behind the notion of customer profitability. We’ll start with the conclusion (the one I’m contesting) that some customers are more profitable than others. And — for the sake of this exercise — we’ll assume it’s true.

So we have a profitable customer. What does that mean exactly? Well, I guess it means that when you take the gross profit generated by that customer’s transactions over a period and subtract the operating costs that can be attributed (directly and indirectly) to that customer, the result is positive.

That customer is profitable, right?

If you were to perform the same exercise across every customer your organisation has, then you would undoubtedly discover that some are more profitable than others. You may even discover that you are making a loss on some customers!

If so, you can increase the profitability of your organisation by eliminating the non- (or less-) profitable customers, right?

Wrong!

Let’s say that you start with 100 customers. Some are very profitable. Some are marginal. And some are unprofitable. In order to increase your business’s profitability, you eliminate your 12 unprofitable customers (you send them to your competitors). Now, to determine if your profitability has increased, let’s repeat the analysis above.

Take the portion of operating expenses you allocate to customers. Now subtract the cost savings associated with your reduction in customer numbers. For a quick estimate of those savings, subtract your current organisation-wide payroll
expense from your previous organisation-wide payroll expense. Obviously, the difference is due to the number of staff you laid-off when you reduced customer numbers.

But what if your organisation-wide payroll expense didn’t change? What if you didn’t lay anyone off? Or what if you just shifted a few staff to other departments? Well, in this case your cost base didn’t change, did it? So, in performing the new analysis, you should attribute exactly the same operating expense to your, now reduced, customer base.

Now, a funny thing happens. When you allocate those same operating expenses to a smaller number of customers (88), the overhead burden — per customer — increases!

Now, all remaining customers are less profitable. Worse still, 23 of the remaining 88 customers that were marginal previously are now quite unprofitable.

We’d better send those customers packing now.

I guess you can see where this logic is leading us. If we eliminate ‘unprofitable’ customers without decreasing operating expenses in *direct proportion* to our decrease in customer numbers, we will have, before long, no customers. And — believe it or not — with no customers, our business will make no profits. None at all!

So, will operating expenses ever decrease in direct proportion to decreasing customer numbers? Of course not! There will always be some operating expenses that are not directly associated with customer numbers (head-office costs). Furthermore, there will always be some infrastructure that cannot be disposed of in neatly divisible units (ever tried sacking three-quarters of a customer-service representative?).

So there’s the flawed assumption (costs are directly linked to customers) and the damaging consequences of applying this assumption to our decision-making process:

  1. We eliminate customers that perhaps we should retain
  2. We send those customers to our competitors, and — in the process — potentially increase their profitability and, consequently, their ability to compete more aggressively with us for our remaining customers

Now, here’s the challenge.

I wonder if you’d like to suggest answers to the following questions:

  1. Does it ever make sense to dispose of customers?
  2.  If so, what method should be used to (a) arrive at this conclusion and (b) to choose the customers to dispose of?

Here’s a massive hint (for those of you who are still not familiar with the Theory of Constraints): the output of a process is determined *only* by the resource with the lowest capacity (think of a chain’s weak link).

If you’re struggling to answer these questions, I have one more suggestion. Send this e-mail to your accountant and ask for his or her response. After all, the accounting profession is one of the biggest proponents of the notion of customer profitability! Of course, your accountant is welcome to join this list and participate in the debate.

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Home Forums Is there such a thing as ‘customer profitability’?

This topic contains 1 reply, has 2 voices, and was last updated by  Stan Heard 6 years, 8 months ago.

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    Stan Heard

    It makes sense to dispose of customers when they fail to be fully participating in the relationship. They fail to pay their bill after repeated attempts to collect. When that happens you should discard them and find new customers because you have invested hard dollars (totally variable costs) and you must now invest additional dollars for collections.

    When you can identify and attract replacements easily and find you have slow or no-pay accounts it is best to move on to new and better accounts.

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