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Measuring Customer Profitability

How does a business measure the profitability of their customers? It’s not easy. You can look at what they just bought and compare the revenue from that sale to what your cost was to make that sale, resulting in your profit. Or you could consider what long term value that customer will have with you and compare that revenue with the costs associated with keeping them as a client. Or you could simply guess (although I must advise against this method). However you do it, or don’t do it, it’s important for a business to understand how profitable their customers are and plan their sales and marketing efforts around that critical customer information. After all, you need to generate a healthy ROI for your business to survive and thrive.

Color My World

A very simple way to track profitability is to color code each client. Whether your client list is managed in a spreadsheet (Yuck! The thought!) or in a CRM product (highly advisable), you can assign a color code to each client’s profitability level, or even just a letter or number code. By doing so, you can select out those that are most profitable and prioritize your marketing and sales activities and resources around their needs. The lower the profitability index (color, letter, number) the less resources, energy, time, money, etc you spend on that client. This form of smart spending will give your valued customers what they need while giving you a better return on your investments.

You can do what the airlines do by assigning service tiers based on usage. The more miles you fly, the better service tier you are in and, hence, the more perks you earn. This has the affect of keeping customers longer, since they want to collect all those points to redeem for free stuff (e.g., a flight to see Mom on her birthday). However, don’t confuse longevity with profitability. They could simply be staying with you as a client because they figured out how to work your system but generate little profitability for you.

The Balancing Act

When focusing on your profitable customers, you want to avoid assigning fixed-costs to the resources you apply to develop their loyalty. Fixed-costs tend to map to your company’s choices, not the customer’s. So you may miss out on delivering the types of services your customers want and need. Your costs may vary depending on the customer type, the loyalty program, or the amount of profitability of each client. Likewise, Marketing expenses also skew your measurements since many marketing campaigns reach out to unprofitable customers.

Once you’ve analyzed your clients’ purchasing history (amount purchased, costs, profits, frequency, volume, etc.) to determine their profitability, you can measure the “value” of each customer. When their value is established you can assign, or un-assign, resources accordingly. There is a careful balancing act you have to play here since you should try to apply just the right amount of resources to get the best return on your investment. Apply too many resources to an unprofitable client, and you’ve wasted money. Apply too few resources to a valued client, and you risk losing them.

More importantly, the balancing act has to be played with the different types of profitable customers. Customers with a high present value (just made a large purchase from you) are not the same as those with a high future potential (they’ll keep buying from you over time). It takes more than just measuring their worth by the number of products you just sold them or the amount of revenue generated from one sale. It’s more about the customer’s Life-Time Value (LTV).

Many businesses don’t spend enough time and energy developing customer retention strategies to build loyalty and long-term relationships after the sale. As a result, they make a single purchase and never hear from the client again. Typically, that’s because the client never heard from them after the sale either. The effect of customer retention can be dramatic. Just a small increase in retention can make a huge difference in your bottom line. However, you have to make sure you are retaining the right, profitable-type customers.

Fire the Bum!

So what do you do with the not-so-profitable customers? Firing them is a little harsh, but the intention is right. By reducing your costs (to sell, market, support, etc.) on non-profitable customers, you won’t necessarily save money because you will end up reallocating that money to pay more attention to your profitable customers. Thus, you’ll spend the same amount but with a higher ROI.

As to your non-profitable clients, ignoring them doesn’t always work since the outcome could be bad feelings and negative press about your service policies, customer care, etc. Also, you never know when one of them may start buying from you if their needs change, they get different management, or whatever. What you can do with them is direct them to resources that don’t cost you a lot of money. Instead of spending costly marketing dollars on them or wasting valuable sales resources, route them to lower cost alternatives such as your web site, which could answer questions about pricing, product features, availability, technical issues, etc. Perhaps you could charge them for service calls instead of supporting them for free. Offer them an annual service agreement where they’d be able to contact you a certain number of times a year at no additional charge. Also, simply stop wasting valuable sales resources by making useless sales calls and visits that don’t turn into sales.

You can even use your web site or phone system to avoid human intervention by using automated voice activation to route them away from your more valuable resources while addressing their concerns automatically (punch in your account number to listen to your payment status). The airlines do this all the time with flight information. When you call the airline to check the status of a flight, you never talk to a live person, but you easily get an answer to your question simply by entering your flight number. Whatever you do with your unprofitable customers, affordably keeping them around could be beneficial since they could become a profitable customer in the future.

Tracking the profitability of your customers will help you better manage your business while improving your customer retention. It requires understanding who your more profitable customers are so you can pay more attention to satisfying their needs. It also requires knowing who your unprofitable customers are so you don’t waste valuable time and resources on non-revenue generating activities. Measure profitability, adjust accordingly, improve your ROI, and keep your good customers coming back for more.