Focus on Your Most Profitable Customers and Help Reduce Their Costs
The fundamental problem with the common practice of focusing on aggregate revenues and gross margins is that neither reports the true bottom line for each transaction, they wrote. Gross margins do not include sales and marketing costs, operating and supply chain costs, or overhead. Clients of Profit Isle are always shocked to find out that when these and the cost of providing support to their B2B customers (such as for frequent, small orders or to fulfill special shipping requests), most are not profitable.
"For most companies, only 10% to 15% of their customers are very profitable to serve, which we call Profit Peaks, accounting for almost all the net profits," said Wass. "Another 15% to 50% are what we call Profit Drains, which are actually causing significant losses. The final group of 65% to 75%, Profit Deserts, are companies of any size whose purchases are small or do not result in a significant profit or loss. When clients see this breakdown, their impulse is to try to immediately fix the Profit Drains, but many of these are just price shopping and there is no easy solution. It's counterintuitive for many leaders, but the best near-term improvement in profitability comes from developing a closer relationship with the Profit Peaks. They are the most loyal customers, not the complainers, but that has typically resulted in their having been given little attention. If managers concentrate on increasing the sales to Peak customers by 10% to 15% and converting 20% of the Drains to become Peaks, which is very realistic, overall profits are likely to increase by at least 10% to 30%."
The Deserts that cannot be served in a significantly profitable way can have the cost to maintain them reduced, such as limiting the frequency of orders, having them place orders through the website, and eliminating special shipping and handling requests. This is the first step in growing profitability by "choosing customers" to fit into a relationship hierarchy, they wrote.
The key to being able to analyze which category each of the client's customers belongs in is Profit Isle's program that measures all the true costs of each transaction, "an all-in profit-and-loss analysis for each invoice line, which we call a profit stack," they wrote. Then with this information, the client can build a closer relationship with its Peak customers by showing them ways they can save money across their entire operation.
One of Byrnes' earliest, Baxter, a hospital supply company, is described in the book. Among the products they distributed were intravenous solution drip sets and a five-year contract with a hospital, negotiated with a pharmacist, might hinge on whether the price was $1.03 or $1.05. Baxter decided to find out what the full cost was for one hospital by the time it was given to the patient to determine if it could help reduce that. The products flowed through an internal supply chain that was very inefficient so that by the time the IV was administered, the cost (based on labor rates) might reach $7.
Baxter was able to cut in half the internal hospital cost by process improvements, including fewer trips by skilled nurses to get IVs, installing the industry's first vendor-managed inventory system, and limiting shipment verification to just a sample of high-value products to speed getting them on the shelves. As it expanded this system to other customers, Baxter was surprised that its own operating costs dropped 30%, while sales rose 35%. But one of the most important lessons in the Age of Diverse Markets, Wass says, is that there are no cookie-cutter solutions that can be applied to all customers across all market segments.
Becoming a Value Entrepreneur
There is a lot more to creating a dramatically improved relationship with the most profitable B2B customers than simply saving their product and service costs. It starts with getting to know them far beyond what the usual surveys and interviews yield, Byrnes and Wass argue. Large companies can have managers spend a fair amount of time at customer operations initially. Smaller firms should find the most effective ways to get deeper information, from setting up walkthroughs at the facility by their CEO and a key investor to having working meals with a variety of managers. The goal is to become a "value entrepreneur," seeking maximum insights to help the customer become more profitable, while providing other valuable services. Properly treated, Peaks are going to cost more to serve, but the more closely integrated relationships pay their way many times over, and competitors will find it hard to break them.
You can also apply your newfound skills to your most important supply chain members to create win-win cost savings and optimization at every stage - relationships that could be invaluable if there are supply shortages.
Ideally, a multi-capability team works out the goals for the customer, gets buy-in, and implements the process so that it will quickly prove its value across a range of areas, from improving their own customer service to optimizing their website. Small companies could draw on key shareholders and mentors for help. Wass says that while they previously offered their software only to large companies, in 2021, they have started working with consultants who can scale their services to work even with startups.
"In a year or two, we should have a new version of our program that will be affordable for small companies and meantime, entrepreneurs can work with investors and advisors to make sure they build into your DNA a focus on transactional profitability," said Wass. "You can have 1,000 customers and 600 products and track this on a spreadsheet now. If you treat your finance people as part of the strategic team, instead of bean counters, they will create the data you need. Then if you choose the right relationships with your customers, align your practices appropriately for each category, and manage the process to meet their evolving needs, you will build a defensible fortress around your business that even digital giants cannot easily penetrate."
About the Author
Scott S. Smith has had over 2,000 articles and interviews published in nearly 200 media, including Los Angeles Magazine, American Airlines’ American Way, and Investor’s Business Daily. His interview subjects have included Bill Gates, Richard Branson, Meg Whitman, Reed Hastings, Howard Schultz, Larry Ellison, Kathy Ireland, and Quincy Jones.