Part Two of Three Parts: Factors Impacting Customer Profitability
In the second of a three-part series on how to recognize if you're losing money on your largest customers, Florida CFO Group partners Betsy Bennett, Mark Brown, and Jay White discuss the factors impacting customer profitability.
Is Customer profitability an issue from the start of the relationship, or does it erode over time?
Betsy: It depends. I think the whole key is that you need to have some mechanism to try and measure customer profitability, either an interactive system that works with your general ledger system or an ad hoc financial analysis that you do on a periodic basis.
Jay: A problem you frequently run into is your largest customer not only negotiates the lowest price possible, but also requests you provide additional engineering, administrative or selling services free of charge.
Mark: The vast majority of the time when I sit down with a new client and we look at the customers they feel are profitable, we find absolute surprises that change their strategy.
Jay: We often find hidden costs on the balance sheet. What we are seeing over the last number of years is bigger customers are trying to push down the cost of the supply chain to suppliers. One of my client companies just received a request from a very large customer to cut our lead times, which if you translate that, means carrying a larger inventory along with its associated costs.
Where to Start with Unprofitable Customers.
Jay: Well, typically when I go into a company and they're losing money on a big client, they don't have a lot of excess funds to implement additional accounting and finance operations. So, we have to look at each customer and make judgments on what we're going to do.
You often get into looking at how they price in the first place and find they're doing something incorrect. So, not only are you attacking their existing client base, but you're helping them price on future clients.
Betsy: You can model pricing and profitability. If they're not a current client, you're going to be projecting it using certain assumptions, but it's a prudent thing to do -- particularly if in the agreement you're entering into with the customer you can specify the expectations of scope. Then if the scope differs from what was expected, you have the mechanism to go back and renegotiate the price.
Large Customers Command Different Pricing.
Jay: When you deal with a huge company that has a whole department whose sole existence is to beat down your price, you're going to have to make some sacrifices if you truly think that business is in your strategic best interest.
This can be a situation where you're overly dependent upon one sector of an industry and you want to get into another sector. You may have to be a little lower on your pricing, on your margins, to get a foothold. But if you're not careful, that can be self-defeating. It's very tricky to "buy" market share with pricing. You really do need to understand your profitability to do this.
Mark: You can lose money on small customers. You can lose money on big customers. The customer size really goes back to looking at the profitability in different ways. And usually the way this thing gets started is the CEO or the entrepreneur will come up with a new proposed big customer, or a big or a new product line where you have to take a look and make a judgment on it. That's the easiest way to get the entrepreneur excited about this concept -- when he or she is looking at a new program that might require some special pricing, some additional investment, that may change things.
Betsy: And attracting smaller profitable customers as a result of having a big strategic customer can pay off. But you'd have to look carefully at the overall strategy of having a big customer at breakeven.
Jay: You'd have to have a pretty good game plan in place to intentionally take on an unprofitable customer. You have to have an almost iron-clad game plan or strategy to do that.
Mark: When we do the analysis, it's almost never cut and dried as to what the answer is. There's almost always positive and negative factors, advantages and disadvantages, of doing these sort of things. My approach is to define the risk and present what I recommend.
Jay: Right. Plus, when you're dealing with a big customer, you may not be dealing with just one product. We have some big customers with one of my clients, where we sell them upwards of fifteen or twenty different products, and some of them turned out to be less profitable than we thought. So we are discussing with this client that we cannot continue the existing pricing on these very unprofitable products.
This is typical of most cases I've seen, it's not just one product to one customer. It's a family of products; and some of them can be profitable and some unprofitable. In that case, we work on the unprofitable to improve margins.
In the third and final part of this series on how to recognize if you're losing money on your largest customers, Florida CFO Group partners Betsy Bennett, Mark Brown, and Jay White, will discuss turning around unprofitable customers.
About the Florida CFO Group
Founded in 2010 the Florida CFO Group provides CFO services and support in raising growth capital, mergers and acquisitions, recapitalization, or structuring to meet ongoing opportunities to Florida's growth companies. The Florida CFO Group's partners have been providing CFO services on a fractional share (part-time) or interim basis over the past decade and specialize in cost-effective financial reporting, budgeting, forecasting, controls and financial management. Each embodies a wealth of financial skills as well as experience in servicing clients in a consultative CFO manner across markets including agriculture, construction and development, government contracting, healthcare, manufacturing, not-for-profit, private equity, real estate, technology, and wholesale and distribution.