Increasing Industrial Distribution Profitability by Segmenting Customers, Suppliers and Products-Part 4 Customers
Customers: The bell curve is a standard statistical concept that works for most large groups. The following is a simple division of the customer base that should work for small-to-midsize companies. Larger firms may divide customers based on other parameters. For example, by country of origin or there may be different groups for original equipment manufacturers (OEM) customers that are separate from maintenance, repair, and operations (MRO) customers.
The minimal segments are “best customers” (top 10 to 15 percent that are measured by contribution to gross margin), “profitable customers” (customers with a positive contribution to gross margin), and the “bottom customers” or “probationary” (those who do not have a positive gross margin contribution). This last group is made up of two subgroups.
The first are “prospects” or potentially profitable customers (new customers or those that are growing and can be projected to becoming profitable). The second subgroup are the “should be fired” customers, those who are not making a positive contribution to gross margin and probably will not in the foreseeable future.
Best customers are not necessarily the ones who spend the most money but are the most profitable. By using activity based costing (as defined above), it is possible to calculate contribution to net margin for any customer. Then the customer base can be forced ranked from top to bottom.
There is also value in using metrics to define a Pain Factor (PF) for customers. Those who require the most handholding, are always late paying, require many special services, and provide little or no gross margin contribution need to have their pricing increased. In some firms ,a PF is assigned to every customer. A scale of .95 to 2.0 is often used. The best customers get the lowest PF. When pricing an order, bid, or special purchase, the best price is multiplied by the PF to arrive at the selling price. A very high PF may mean that a customer will pay double the amount of the best customer. If the person goes somewhere else for their products, that’s all right because they are not profitable. On the other hand, if they stay and pay the higher price, they become a good customer.
It is also common for salespeople to not earn commissions for the customers in the lowest group. However, it is also reasonable to give a bonus for all new customers if that is a goal of the company. Then another bonus may be paid if and when the new customer moves from probationary to profitable.
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