Every company has unprofitable customers, but few dare to say goodbye to them, no matter how much they may be dragging down the stock price.
Executives at a number of companies have told us that they believe every customer can be profitable. Common sense says that isn't true, but optimism is a virtue, and fixing unprofitable customers is clearly the best alternative, if it's possible. After all, the customer is already in the door, and the company knows something about him or her.
How to make the fix depends on why a given customer or segment is unprofitable. Many reasons are possible.
Too early in life cycle. A customer too small to be profitable today may hold the potential of becoming a much larger, profitable customer in the future.
Insufficient volume. Some customers, while behaving normally, don't buy enough to cover the total costs of serving them, including the capital costs, and will probably never buy much more than they're buying now. Others buy even less and do not cover even the direct variable costs of serving them.
Insufficient share of wallet. Other customers may be too small to be profitable but are doing significant business with direct competitors, so gaining more of their current business would make them profitable.
Bad behavior. Sometimes specific behavior turns an otherwise profitable customer unprofitable. An analogy would be customers of a home improvement store who buy profitable product bundles but are unprofitable because they constantly return and exchange items.
Each reason for customer unprofitability requires a different kind of change in the customer experience, and the appropriate changes will differ from company to company.
Royal Bank of Canada changes the customer experience by changing its own activities to reduce the cost of serving the customer. For example, it can trace a check in one day for a profitable customer but will conduct a much less expensive three- to five-day trace for an unprofitable and unpromising one.
Fidelity Investments conducted extensive research into why some of its customers were unprofitable. The trigger was their initial customer profitability analysis, which revealed that 10% of customers in their top segment, Private Access, all of whom maintained at least $2 million of assets with the firm, were unprofitable.
When Fidelity dug deeper into what made some customers unprofitable, it discovered that the main reason, accounting for just over half the losses attributable to unprofitable customers, was excessive channel usage. When a customer who does limited business with Fidelity phones the call center too frequently, or gets on the phone with a branch office, or stops by an office to talk with a representative too often, the costs can easily outstrip any profits.
Fidelity could identify specific customers who were unprofitable for this reason. So when such customers called, Fidelity's reps began teaching them how to use the company's lowest-cost channels, its automated phone lines and Web site.
The cost differences are dramatic. Giving a customer a stock quote by phone from a rep costs Fidelity $13, while giving the customer a quote online costs 1 cent. Fidelity also made its site friendlier, so customers would be more inclined to use it.
These customers could still talk to service reps, but the phone system identified their calls and routed them into longer queues, so more profitable customers could be served more quickly - and the longer wait for the unprofitable customers would be a disincentive to call.
Fidelity couldn't lose. If these customers switched to lower-cost channels, they became profitable. If they didn't like the revised value proposition - slower service by phone but better service online - and left, Fidelity was more profitable without them.
In fact, however, 96% of these customers stayed, about the same retention rate as in the industry over all, and most of them switched to lower-cost channels. Over time smaller customers actually became more satisfied as they learned how to save time and get faster service; that is, the company was meeting a previously unmet need.
In addition, Fidelity's operating profit increased. The new value exchange equilibrium ended up being more satisfying for both the customer and Fidelity.
Fidelity's experience can be generalized to what happens when companies revise value propositions for unprofitable customers.
- If such customers decide to stay, that's an excellent development. Under the new terms they are now profitable customers.
- If the increased prices or modified services cause these customers to go elsewhere, that also is fine, because they are no longer reducing the company's profits. Fidelity Investments found that one of its customers, with a portfolio of only about $500,000, was asking for so much help and information that he was keeping three of its financial advisers busy virtually full-time. Eventually the company reluctantly and very politely asked him to go elsewhere. A different company in a similar situation might have tried a different course, charging for customer counseling.
What about the "sell" option? You can sell a business, but how can you sell an unprofitable customer segment?It isn't easy, but some companies can come close. When financial services firms structure business units around segments these units can be sold.
The particular appeal of this course is that your competitors may not have done the segmentation and profitability analysis you have done - especially if you have carried the analysis to the point of calculating profitability and shareowner value creation.
Or maybe your buyer's value proposition is crafted in such a way that it makes sense for your unprofitable segment.
Not managing your unprofitable customers can have a huge cost. They are killing your stock, frustrating your most dedicated, hardest-working employees, and robbing valuable resources from your most profitable loyal customers.
