How Firing Clients Can be Good For Business by Neil O’Brien of Quantum Business Solutions
She didn’t hold back. “Neil, have you lost your mind? Fire customers – fire 37% of my customers!! Are you insane?”.
Her reaction was both expected and not unusual. But unfortunately for Sharon, the numbers don’t lie. I had just completed my 80:20 analysis of her accounts and worked out the net profit/net loss per customer. And the bad news for Sharon was that 37% of her customers were losing her money.
How is this possible? Surely all customers are good, right?
Sharon owns a business making blinds and curtains. While the 80:20 analysis showed that 37% of customers lose her money was a huge surprise to her, unfortunately it was less so for me, as I have seen this trend many times over the last twenty years.
Like many businesses, Sharon has a mix of customers, some of whom spend thousands while others spend hundreds. And it’s the smaller customer orders which cause the problems, as there is a minimum amount of time and effort which must go into each one.
All these steps must be followed whether the order is for €100 or €1,000. Many of Sharon’s orders are €200 or less. While the gross margin is around 53%, each order consumes overhead costs like rep salaries, transport costs, administration costs and fitters’ wages. Gross Margin is the difference between selling price and the cost of materials so if she had a sale of €200 and the material cost was €90, the gross profit would be €110, €200 – €90 = €110. This is often expressed as a percentage of gross profit divided by selling price or €110 divided by €200 = 55%. On top of this, a portion of all overheads must also be allocated to customers, as this is the only way these costs can be recouped. An allocation of overheads must be made to each order for rent and rates, insurance, phones, marketing, accountancy, stationery, etc. Without even getting into the numbers it is easy to see how orders of less than €200 will lose money.
As we saw in the earlier chapter with Mrs Murphy, there is a minimum cost of doing business with any customer – remember not all customers are the same.
Most business owners don’t realise or appreciate just how high this figure can get. While most pricing and costing systems can work for larger orders or medium-size ones, they do not adequately cover the costs involved with smaller customer orders.
This is how Sharon is losing money on 37% of customers.
So what are her options for dealing with these customers?
- Increase selling prices.
- Reduce the level of service.
- Try to sell more higher value orders to loss making sardine customers.
- Send them to her competitors.
From my experience, the main option is number one and while some customers will still stay, many will move to a competitor’s business. This is often the source of much amusement for my clients as their competitors welcome these loss-makers with open arms, not realising that they would probably lose money on these small value orders.
How applicable is all this to your business? I would be very surprised if something similar does not apply to your business.
How do I know this? Because 80:20 is a natural law, just like gravity, so you can’t really escape it. I suggest you crunch some numbers and work out the cost of dealing with smaller customers. And just like Sharon and many more, you may have to put up your prices and say goodbye to many of these loss-makers.