Part Three of Three Parts: Turning Around Unprofitable Customer
In the third and final part 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 turning around unprofitable customers.
Turning around an unprofitable large customer relationship.
Jay: We have some big customers with one of my clients, where we sell them upwards of fifteen or twenty different products. I would say three-quarters of the products that we sell are profitable. So, we're working with the bottom quarter to begin with. We've sent these customers a letter notifying them of a price increase with the understanding we'll continue the existing price for six months while they find another supplier if they do not want to go with the price increase. In some cases, they take the unprofitable parts elsewhere, but many have accepted the higher price and stayed with us. But, if they take an unprofitable part away, it generally is not that big of a deal as we were losing money on that part to begin with.
Betsy: So, they typically keep the other parts with you?
Jay: We haven't lost the profitable products. We've only lost the unprofitable products. But in each case, we analyzed what it would mean to lose the whole customer, and we're willing to run that risk. But maybe it's just the time in this economic cycle because we're backlogged.
Mark: Maybe that's sort of the crux of it, that each situation is a little bit different, and almost never is there just a black and white answer. It's all about trade-offs, and that requires a discussion among people that understand the strategy.
Jay: Yes, but if this were 2008, we probably would not be putting out letters with price increases to our customers.
Mark: Even if you've got additional capacity, you might or might not want to let the customer walk away. Many times, you may see something happening three, four, five months from now. You might be in the position where you have to add capacity in the future so you have a different perspective. You might want to lay somebody off now, or reduce cost, or you might decide to defer that decision.
Betsy: I think we skipped over the step when you realize that a product or a customer is unprofitable, the first thing you look to see is if there's cost in the equation that you can get rid of, if you're being wasteful and not as efficient with your process is to deliver a product or a service. So that's the first course of action you go to. When you determine that you're being as efficient and effective as possible, then you would go to the customer to say look, we need to renegotiate.
Mark: And to take Betsy's example of the call center support hours; it might be you can go to the customer and see if there a way for you to reduce your costs.
Betsy: This was a call center supporting multiple financial institutions' customer credit card programs. What we discovered was this particular customer was running very, very low credit limits for their customers leading to their customers making multiple calls in to see how much credit they had available. This was approximately ten times higher call volume than other financial institutions.
Mark: But going through that analysis enables you then to come up with a different pricing structure for customers you're not even looking at initially.
Betsy: In this case, after both pre- and post-activity based cost accounting and profitability modeling, we went to a tiered price structure where we had six different tiers of pricing depending on different attributes of the relationship. We achieved over ninety-eight percent of the customers being profitable once we fit them into one of those six buckets.
Understanding your costs are in advance of taking on clients.
Betsy: You can model costs and profitability based on certain assumptions and it's a prudent thing to do, particularly if the agreement you're entering into with a customer lets you 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.
Mark: A lot of costs are step costs, not incremental, as in my example of the client that had a quality department just for one customer. The department goes away if the customer goes away. However, there are situations where it's not just as straightforward as just plugging in the numbers. It requires somebody looking at things and making judgments – it's almost always gray, not black and white.
Betsy: This is where bringing in a higher-level resource that's able to do the analysis from an activity based approach that can truly assist the company become more profitable. You're adding overhead as you're adding to the finance and accounting team. But if it's helping you manage your customers better and get higher prices, it will pay off in the long run.
Final Thoughts on Not Losing Money on Your Largest Customers.
Betsy: I think an entrepreneur or CEO needs to have someone available to them that really understands how to analyze the cost side because usually the sales department or the entrepreneur understands the revenue side. So they really need to understand the cost side to be able to drive it down to a profitability equation on a customer basis.
Jay: Yes, I'll go along with that.
Mark: And it's usually not the direct costs that are mislabeled or misallocated. It's all those indirect costs.
Jay: I think one of the things we bring to a company is the ability to sit the owner down with the salespeople, once we have the numbers, and determine where we are going from here. What is the game plan for this customer and is it desirable to keep them? Are they profitable and if not, is there some way to make them profitable? We can be the central point, in a company, for that discussion.
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.
