by Dr. Albert D. Bates, Profit Planning Group
Each year, Dr. Albert D. Bates, the president of the Profit Planning Group, prepares a Profit Improvement Report for CTDA.
What follows is part two of this report, which Bates has entitled “Harpooning the Whale.” In this section, Bates examines Changing the Profit Relationship – a discussion of how profitability can be enhanced by working with customers. Part one, which focused on Economics of Customers – an analysis of how customers break out into widely-varying profitability groupings – appeared in the January 2016 TileLetter Business Tip section. This installment picks up with the first chart, which illustrates the profit profile of tile distributors. The two-part series is provided by CTDA.
The typical CTDA member generates $500,000 in profit. For that firm, the customers fall into four categories based upon the profit they generate for the distributor. The A customers are the most profitable and the D customers are the least profitable – the money losers.
The relationship for customers and profit tends to be a little more dramatic when put into tabular form:
The fact that the typical firm loses $225,000 on slightly more than one-third of their customers is not an inconsequential issue. Potentially, dollar profit could be increased by 45% through concerted effort.
The immediate, knee-jerk, reaction is to just fire the D customers. In point of fact, this is an approach that some analysts support. It is an approach that should be avoided. Instead, it is essential to break the customer base into three target groups and work with them systematically.
Group One – A Customers: In the rush to focus on the money losers, there is a tendency to overlook the most profitable customers in the mix. It is actually more important to support the A accounts than it is to worry about the D ones.
No customer set buys all of their needs from one supplier. Anything that can be done to encourage A customers to purchase more has a direct and immediate impact on profitability. It is also a positive set of actions that everybody supports.
Group Two – The Down and Dirty Two Percent: Anecdotal evidence suggests that somewhere around 2% of all customers are not just unprofitable for the distributor, they are highly unprofitable. Even worse, they probably enjoy being unprofitable. These customers really should be fired.
Care must be exercised in the firing. Today’s fired customer may become tomorrow’s acquirer of one of the best A customers. The simplest approach is to simply let them fire themselves. This involves systematically moving them to a different, higher, category on the pricing schedule.
Group Three – The Mass of D Accounts: After the members of Group Two have been eliminated, there remains a massive number of accounts that still produce a gross margin that does not cover the cost to serve them. It is a lot of customers and requires a lot of work to correct the situation.
There may be some opportunity on the pricing side with these accounts. However, most of the effort must be devoted to the issue of the cost to serve. This inevitably gets back to the reality of too many small orders, too many emergency orders and too many returns.
The key is to get customers to plan ahead and ultimately place fewer orders. Alas, customers place the number of orders they want to place. Time and effort must be spent to educate customers about the cost savings on their side of the profitability equation if they were to order less frequently. It requires both an analytical effort and a sales effort. The profit impact, though, justifies the effort.
A lot of firms are aware that some customers are unprofitable to them. What is needed is a more precise analysis of the nature of the challenge. Once the analysis is conducted that analysis must lead to action.
Dr. Albert D. Bates is founder and president of Profit Planning Group. His recent book, Breaking Down the Profit Barriers in Distribution is the basis for this report. It is a book every manager and key operating employee should read. It is available in trade-paper format from Amazon and Barnes & Noble.
© 2015 Profit Planning Group. CTDA has unlimited duplication rights for this manuscript. Further, members may duplicate this report for their internal use in any way desired. Duplication by any other organization in any manner is strictly prohibited.