Here's an interesting exercise for any distributor: ask different people around your company who your top five best customers are.
Chances are you will get many different answers, depending on who you ask. Sure, most people in your organization can probably point to a handful of your largest accounts, but do they really agree on who your best customers are? By "best," we mean the ones that are high margin, high volume, and loyal customers with low cost to serve. In other words, which customers are the most profitable, high-performing accounts that drive your business forward?
I recently spoke with a distributor whose sales rep was seeking an additional discount for what he felt was a deserving customer. "They're a great customer," said the sales rep. "They're always calling in with new orders." The executive was hesitant. "That's just the problem," he stated. "They should be placing those low-dollar orders over the Web so they cost us less to process!"
And therein lies the problem: each person's perspective results in a different answer. Your CEO, CFO, Sales Managers, Customer Service Reps, and others all have varying opinions of who your best customers really are. No one has gone through the exercise to figure out each account's true cost to serve.
A number of distributors have tried Activity Based Costing in the past. I say "tried" because that's the response I hear most often; very few have been successful in maintaining such a program, citing complexity, time, and tedious activity as the main obstacles. The result is a general lack of understanding in the industry as to what percent of a distributor's overall customer base is unprofitable business.
In his book, Islands of Profit in a Sea of Red Ink, business consultant and MIT senior lecturer Jonathan Byrnes claimed that 40% of most businesses are unprofitable. The unprofitable portion of the company's business often goes unnoticed because it is subsidized by the company's top-performing customers. Surely, this can't be the case in distribution…can it? Can nearly 40% of your customers be unprofitable business?
One distributor I spoke with thinks so. He claimed that, after much research, they learned that 87% of their net profit was generated by only the top 5% of their customers, and that 43% of their customers represented only 2.5% of their sales. In other words, 43% of their customers were the kind of business they did not want to be doing. However, simply selling more product is not always the answer to improved business performance. If your cost to serve exceeds your margins, you're actually hurting your company by selling more.
Distributors need to invest in tools to better understand their customers' true cost to serve. Only then can decisions about pricing, shipping and deliveries, and other special services be made for specific accounts with the confidence that they're not going to erode your margins in the long run. Sometimes, your strategy is best defined by what you say "no" to. But you need the data to support those decisions.
Customer Profit Analyzer is a new solution from Epicor that provides distributors with a tool for understanding each customer's net profitability and true cost to serve. The application will segment and grade your entire customer base so you can finally agree as an organization who your best- (and worst-) performing customers are and why. Learn more about Customer Profit Analyzer.
Posted by Scott Frymire, Senior Manager of Product Marketing at Epicor Software Corporation