Planning for Enhanced Profitability
Updated: Jan 9, 2019
You started your business 5, 10, 15 years ago and grew it by offering a service or product to a customer base. Because you were a start-up, or acquired an existing business, you looked for opportunities to continue to grow your revenue stream to fund the operation. You still remember that first customer; you know the one. They were someone who believed in you to give you a chance. Now, your business has grown and you have many more customers, and you still have that very first one who has been with you since the beginning. Sound familiar?
But now, as you have grown, your customer list has increased and you continue to have those customers that may not be the right fit for your business going forward. Others might be the right fit, but need to be serviced and/or managed differently. Yet, we are expending a significant amount of effort to get less of a return.
We've all heard of the Pareto Principle, the 80/20 Rule, or the law of the vital few. In general, it states that 80% of the effects come from 20% of the causes, or applied to business, 80% of the revenue comes from 20% of your customers.
When is the last time you stepped back from your business and truly evaluated, in a very mathematical way, the Pareto Principle in your business? Which of your customers are the "vital few" that generate 80% of your revenue. Or, how I like to look at it, who are the "vital few" who contribute 80% of your margin; because, those are the customers I want to focus on. But, you say, I've worked so hard to grow my customer base!
When was the last time you went on-line to look for a particular pair of shoes or piece of clothing? I just went on line this past week to look for a pair of tennis shoes I had seen in the store, but they didn't have the right size. Now, you think that would be easy. I knew what store and the shoe, but I had to search through pages of on-line listings in order to actually find it. Granted, I don't have a lot of patience to shop on-line, unless I can find quickly the exact thing I'm looking for. Looking through pages and pages of options just doesn't work for me. However, when I do buy, I pay less attention to price and look for efficiency in ordering. Now, am I the perfect customer for on-line shopping? Probably not. I'm not one who browses the listings and finds other things that may interest me, thus increasing my spend. Therefore, for me, more isn't better, but better is better!
So, how does this relate to your business and the Pareto Principle? How many of your customers are larger purchasers and buy a standard product from you? How many of your customers are larger purchasers, but want special products, because you're already providing them other standard products? How many of your customers are small and are buying standard products? Lastly, how many of your customers are small and wanting special products? All of these may be customers today, but which ones are generating the majority of your revenue and margin? I would venture to guess that those larger customers buying your standard products or services, make up 20% of your customers, but generate approximately 80% of your revenue.
Assuming the Pareto Principle is at work in your business, how should you be treating each of these customer segments? Should they all be getting the same level of service and pricing? Do you even want some of them as your customers moving forward?
In order to maximize margin in business, applying the least amount of resources to service those that generate 80% of your business, will maximize that return. So, does that mean you fire every other customer that's not in that 20%, generating 80% of the business? Well, by doing that, new customers will end up in that bottom tier. It's a never ending process of weeding the garden.
Lastly, looking at your business mathematically, you will likely discover that the first, or one of your first customers, is probably not contributing to the 80%. The ability to evaluate your business based on the understanding of who is contributing, and the effort your are exerting to achieve that return, is the starting point for you to simplify your business and take action to begin segmenting and/or exiting relationships that either aren't contributing to your 80%, or can't be moved up the list so that they can be contributing in the top tier.
If you want to learn more about how to begin focusing your business and setting the stage for the future, consider attending the RiskNet Seminar on Tuesday, April 21, 2015 from 7:30 a.m. to 9:30 a.m. at the Bemis Conference Center, St. Norbert College, where I will be the keynote speaker. The seminar is complimentary and you can register by clicking on the link CLICK HERE TO SIGN UP.
Jayne McQuillan, CPA, MBA, CEPA is a strategic management consultant, and the owner of Journey Consulting, LLC, in Green Bay