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This Focused Performance Weblog started life as a "business management blog" containing links and commentary related primarily to organizational effectiveness with a "Theory of Constraints" perspective, but is in the process of evolving towards primary content on interactive and mobile marketing. Think of it as about Focusing marketing messages for enhanced Performance. If you are on an archive page, current postings are found here.

Saturday, February 22, 2003

Customers - Love 'em or Hate 'em, Never Forget You Need 'em -- Back in September of 2002, I came across an article in Fortune that has been sticking in my craw. The article, Will This Customer Sink Your Stock?, put forth a case for assessing the "profitability" associated with customers and classes of customers, and using it to discourage customers that were perceived to be reducing the value of the firm.

My immediate gut reaction to the article was that it was a clear example of local optimization, "cost-world" thinking, and the bad advice that can come from allocating costs to pieces of the transaction, whether those pieces are products or customers. Most of the examples in the article focused on the "cost" of attracting or serving particular customers as an offset to the revenues associated with that customer. In aggregate, this is something that must obviously be managed carefully, so that operating expenses don't exceed financial throughput (revenues minus purely variable costs of the transaction). But my sense of the article was that trying to make pruning decisions about "customer portfolios" is far more fraught with uncertainty than such decisions about product portfolios. And the kind of thinking that the author exhibited, relating illusory costs of activities to incremental spending of customers fails the same test of logic that makes allocation of expenses to products and product for portfolio decisions ill-advised.

If an organization has the capacity to serve "less profitable" customers, along with "more profitable" customers, then the decision to drive away the former will simply reduce revenues and profits. If costs are then cut to offset the lost revenues -- costs which are associated with the capacity to serve customers -- more or less profitable -- then the capacity to serve the "more profitable" will be threatened.

While the article did have some good advice for and examples of the idea of maximizing revenues by paying special attention to those customers, which is a well-advised strategy, it stresses too much the "value" of driving away the "unprofitable customers."

I've been sitting on this article for almost half-a-year now, but was finally triggered to comment on it by some other pieces brought to my attention by Terry Frazier in Customer Conundrum. After discussing his own experience with the banking industry, Terry points to a Wharton Business + Strategy article on The Customer Profitability Conundrum: When to Love 'Em or Leave 'Em.

Terry pulled out and commented on a couple excerpts, which I encourage an interested reader to check out, but there were a few others that caught my attention, especially as they touch on the subject of market segmentation, a key aspect of a TOC Based Strategy and the development of "unrefusable offers."
""We just finished a project for a client where, when we looked at customer profitability, 30% of the customers created 200% of the client's profits," Rosenbleeth says. "About 50% of the customers weren't very profitable and the remaining 20% destroyed profits. So should the client have cut those 20% loose? That wasn't the answer."

"Instead, the solution was to segment customers into what Rosenbleeth calls tailored business streams. "You structurally change the way you serve different customers to make each segment as profitable as possible," he explains.""
Not specifically addressed in either article, but of foremost importance in such a segmentation is an understanding of the constraints in your own system that limit the ability to serve these segments. The relative use of the constraint by a particular market segment (or product, for that matter) is the key to understanding their relative value.

If a small revenue stream is attainable with current capacity and without requiring attention by your constraint, then that revenue goes darn close to straight to the bottom line. If on the other hand, a "valuable customer" monopolizes your resources and requires significant attention by the constraint, there is little room for taking advantage of new opportunities or for nurturing new customers. I was chatting a couple nights ago with a manufacturer who had a "profitable customer" in Home Depot, who they had allowed to consume significant utilization of their constraint capacity to the point of becoming 50% of their business. I probably don't have to go on with the present condition of the firm, after Home Depot said "thanks, but no thanks" to continuing as a customer. If they had paid a bit more attention to their "less profitable" customers, they might not be shutting down plants and scrambling to contract their suddenly freed-up capacity to their competitors.

To avoid such a situation, a distinction needs to be drawn between a "love 'em or leave 'em" approach to customer relations and one that is more like "love some more and love some less." The rationale for this is summarized in the Strategy+Business article by Wharton marketing professor Barbara Kahn...
"It's more expensive to acquire a new customer than to retain an existing one,"; Kahn says. It's even more expensive to bring back a customer that you've gotten rid of. It's costly and it's a mistake you don't want to make. That's why I believe firing customers should be a last resort."
I'm working with a client right now whose whole operation has been thrown into a tizzy by a particular customer who has jerked them around. It is tempting to think about "firing" them, but then they would only have another even less comfortable situation trying to replace them. Better they learn from the situation, and redefine the relationships so that the whip-saw effect of such dealing with such customers is eliminated or at least minimized to a manageable degree.

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