Fewer Customers = More Profit

I read an interesting case study today, one that defies the common belief that, in order to increase profits, a company must constantly grow its market share. The company in question (whose name was withheld) slashed its customer base by 60% and more than doubled its bottom-line profit as a result. How is this possible?

The answer seems entirely reasonable ... the company dumped customers that were not profitable to serve. Fundamentally, it analyzed its customers in terms of the amount of revenue it received, then cross-referenced this against the amount of cost undertaken to acquire and support each customer. As a result, its customer base was split into four groups:

• High-revenue/low-cost (12%)
• High-revenue/high-cost (9%)
• Low-revenue/low-cost (33%)
• Low-revenue/high-cost (46%)

Naturally, the high-revenue/low-cost is the most desirable of the groups, on which the greatest amount of income is made for the least expense. In the case study, the company felt that it didn't need to do anything more than it was already doing to retain a steady stream of income from these customers.

I balk at that suggestion, as it sounds to me like it's advocating taking good customers for granted, and concluding that paying any more to provide them with better service would not result in an increase in revenue. But I have to concede that it makes sense - and there is a logical point at which a customer is buying as much and as often as he ever will, and additional effort to get him to buy more is pointless. There wasn't sufficient evidence to suggest whether that held true, but my sense is that there was probably a potential for increased profitability with a bit more effort for some percentage of these customers.

On the opposite end of the scale are the low-revenue/high-cost customers. These are customers who will only buy if offered a deep discount and/or require a (costly) effort to get them to buy at all. Even once you've sold them, you have to undertake a similar effort to get them to repurchase. And when you take these costs into account, the company was actually taking a loss on many of these customers - paying more to get them to buy than the company made from the sale. And so, the company stopped trying to get their business.

The high-revenue/high-cost customers were evaluated on a case-by-case basis. These were "primadonna" customers who brought in a lot of business, and felt entitled to volume discounts, special handling, rush service, and all the other "perks" given to high-volume accounts. The problem is that, in some cases, the high revenue was gobbled up by these perks, and some of them were costing the company more to serve than it made from their orders. After careful consideration, about a third of these customers were dumped, just by cutting off the perks (which means that the other two-thirds remained, and that the perks weren't really necessary to retain their business).

The low-revenue/low-cost customers became the focus of the company's marketing efforts - specifically, in determining why these customers were not buying more goods more often, and attempting to coax them into the high-revenue/low-cost category, provided that the amount of effort it would take to win their business would not make them a high-cost customer as well. In terms of investment, these customers gave the company the most additional revenue per dollar spent.

So in the end, the company decreased its customer base to a little more than a third of what it had been - but in doing so, it evaluated the profitability of customers and retained those who generated the most revenue for the least expense. The result was a smaller customer base, but one that was more stable, and a leaner and more prosperous organization.

And as to the customers who cost more than they were worth, the company found that it was better off without them - and if these customers took their business to the competition, so much the better. While it wasn't their intention to saddle competing firms with low-grade customers who would erode their profitability and level of service to their existing ones, it would be a natural side effect.

What's more, the low-revenue/low-cost customer for one firm is generally a regular (high-revenue/low-cost) customer of another, who occasionally buys elsewhere. If the firms that regularly serve these customers are saddled with toxic waste, they are more likely to shop around for a new "regular" vendor, and their top considerations are the firms they've done a little business with on the side.

This last conclusion is largely speculative, and there was no clear chain of evidence that the primary company gained more good customers for having dumped its bad ones on the competition - though it's an entirely plausible notion.