Identify and Develop Your Most Profitable Customers
An intelligent entrepreneur focuses on growing sales with the most profitable customers and best managing the less profitable consumers. The key is to analyze each customer by how much they spend, the necessary resources, and your company’s profit on their business. This approach to an individual ROI (return on investment) may seem complicated. Here are some steps to help clarify the process:
Individual Customer Analysis
Start by analyzing each of your customers, beginning with your least profitable. For that customer, determine:
- Total spending per specific period of time. Use weekly, monthly, or yearly figures; choose a time period that makes sense for your genre of small business.
- Cost of goods or services provided. Leave out fixed costs like rent, utilities, and other overheads. Focus on the actual cost of the goods or your direct costs to provide a service.
- Cost of additional "services." Some customers require more administrative or sales support than others. Evaluate this customer against your "average" customer. Examine factors like how frequently they call to check on an order status, their return rate, or any outlying needs they may have. Capture the additional cost (if any) of servicing the customer.
Customer Gross Revenue - COG - Additional Costs = Specific Customer Profit Margin
Do the math. Do not include overhead and fixed costs in the calculation. Take the customer’s purchased gross revenue and subtract the cost of goods (or services) sold minus the specific additional cost to service this particular customer. What remains is the profit margin for the specific customer for your business.
Another way to make sure the difference between revenue and profit is clear is to think of a customer who purchases only your premium product with the highest gross margin. This customer may buy relatively less than another customer who purchases only your low-margin products. However, which of the two customers makes you the most money? If you evaluate customers only on sales volume, you might be misled about which customer most benefits your small business from a profit viewpoint.
Evaluate each customer using the same basic methodology. The end result is a profitability breakdown by customer.
Factor in Other Variables
Theoretically, you should focus on growing the most profitable customers, but it’s not that simple. Other factors play a part; a less profitable customer can still provide tangible benefits like:
- Signing long-term contracts and agreements
- Purchasing a variety of products or services
- Providing referrals or enhancing your business image through association
- Enabling entry into growing markets or market segments
Change Your Focus
Adapt your strategy once you have determined your most and least profitable customers.
First, look at your least profitable customers. Do you lose money on any? If you’re like most companies, you probably found a few customers that negatively impact profit margins. If so, consider letting them go, raising prices to more profitable levels, or changing your service approach so that you can make a profit on their business. Sometimes, you may need to find ways to reduce the cost of "additional services" (like non-legitimate support calls). This approach can decrease your total costs for servicing that customer, increasing your profits without raising prices.
Focus on your most profitable customers and how to increase your business with them. Can you sell additional products or services? Should you offer different payment or service terms to encourage more spending? Most importantly, look closely at what makes this group profitable, and try to apply what you learn to your "average" customers.
Ultimately, you want to change how you deal with customers at each level: most profitable, "average,” and least profitable. Work hard to convert average customers into more profitable customers and least profitable customers into average customers. No matter what, take great care of your most profitable customers, as they are the lifeblood of your business.