Thursday, December 6, 2012

How to Recognize Which Customers Are Bad for Business

How can I identify the customers I should shed--the ones who suck up my time and energy in exchange for meager returns?

Most business owners know in their guts that a good chunk of customers are not profitable. But in a universe in which it's drummed into us that the customer is always right, it amounts to heresy to admit that a customer may, in fact, be wrong and should go. It's difficult to send any potential revenue packing, but culling the client list is worth it--it frees up resources to take better care of your best customers.

The Pareto principle, more commonly known as "the 80-20 rule," can be applied to customer profitability. In short, it means that 20 percent of your customers likely provide 80 percent of your profits. Inversely, it says that 20 percent of your customers may be sucking up an astounding 80 percent of your direct customer costs.

The problem is that many small-business owners don't have the tools they need to determine if one unprofitable client is worth nurturing for a big payday down the road, or if they should say, "Sorry, I can no longer work with you," and move on. That's why I'm here to help.

Analyze Profit By Customer

Profit equals revenue minus costs. Simple, right? To analyze customer profitability, we must assign revenue and costs to each customer. For those of you with thousands of customers, you'll want to put them into groups. For example, a restaurant could divvy up its patrons among the breakfast, lunch and dinner crowds; a building-supply house could group retail and wholesale customers separately.

Revenue is usually pretty easy to pull, since accounting systems can match each sale or invoice to a specific customer. Costs, however, are trickier to determine. Without burying you in the arcane world of cost accounting,