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Published in COR

Do you Know How Much a Non-Profitable Customer Costs you?

It’s an unfortunate reality: you have unprofitable customers who are diminishing your value as a brand. Sometimes, you will simply need to divest.

Is every individual customer you have profitable to you? Chances are, the answer is a resounding “no.” That may not seem like a big deal in the long run — why does the value of any one particular customer affect your bottom line? — but your service costs for unprofitable consumers can really add up and affect your entire organization. Business owners and leaders need to be aware of the difference between good customers — those who are contributing to their business in a positive way and helping you build your brand — and customers who are adversely affecting their company.

While customer retention is a reasonable goal, it’s not always beneficial to you — if you’re focusing on the wrong customers and neglecting the right ones.

How do you know if a customer is profitable?

How do you assess the value of a customer? This is a critical part of building your business.

It is important to note that value is not limited to how these consumers are contributing to your cash flow. You should also consider factors like customer loyalty — how long they have stuck with your business. Additionally, think about whether and how they drive offer customer groups to your organization. Referrals also contribute to the strength of your brand. Remember, too, that individuals or groups like thought leaders and influencers may not be creating monetary or tangible profits, but they could be encouraging others to invest in your company and promoting awareness in their followers.

Moreover, think about how much a particular customer costs you. Are you spending less on them than you’re putting forth to retain them? Or is the reverse true? Factor in marketing efforts, customer service, and other aspects of customer service to calculate and evaluate this metric.

You should routinely conduct a customer profitability analysis for your clients. This will allow you to see how much profit each individual consumer is adding to — or detracting from — your revenue. It will also enable you to strategize about whether you should put the effort to retain or even divest customers. The good news is that there are plenty of tools available to help you with this process, including software dedicated to conducting and providing data about this kind of analysis.

What makes a customer unprofitable?

In a nutshell, a customer is unprofitable if they are using more of the resources than they are contributing to your business. In other words, they are demanding your energy — including time and money — without paying off in terms of tangible or intangible profits or rewards.

But it’s a little more nuanced than that. Remember that you can reap intangible rewards from your consumers and clients, so it’s not as simple as assessing the monetary profit or lack thereof from each customer. However, it is fair to say that if you’re spending more on a customer than you’re receiving in return, or even if it’s a draw, then that customer is unprofitable.

There are many factors at play when it comes to determining and calculating the overall profitability of each and every one of your consumers, and we will go into greater detail about this below.

Why is customer profitability important?

You probably know intuitively why customer profitability is so important — if a customer is not contributing to your business in a meaningful way, they are hurting rather than helping. But more than that, assessing this metric will allow you to assess your overall business strategy and see whether there are products or services you should reevaluate and reconsider. In other words, it’s not just about what your customers are doing — it’s also about what you’re doing.

Moreover, taking a close look at customer profitability will enable you to better understand your consumers themselves and how they are using your products and consider and reconsider your customer acquisition efforts.

Ultimately, profitability is a chief objective, unless, of course, you’re operating a nonprofit organization. So, this isn’t something to put at the back of your mind; it must always be front and center.

Do you know who your least profitable customers are?

Often, it can be difficult to know offhand who your least profitable customers are. Conducting a routine and regular profitability analysis will help you figure this out. Keeping careful logs of all customer interactions, from a lengthy phone call to a routine newsletter, including any marketing materials and other resources you devote to each customer group, will also allow you to see the big picture and assess data you may not have considered otherwise.

Why SaaS customer costs are more difficult to assess

Tangible, physical products and services are fairly easy to assess. You know how much money you’re putting forth and how much you’re receiving in return. But when you’re dealing with digital goods, it’s an entirely different story. SaaS, in particular, is something customers will continue to use long after you have completed the sale. And as long as it is in their possession — typically until they stop renewing their contract — you are continuing to provide them with additional intangible services, such as customer support and maintenance.

This is why it’s so difficult to calculate customer costs associated with SaaS products. Transactions are not discrete events. And so much depends on behaviors that are not straightforward to quantify.

Your unprofitable customers are killing you

But quantify them you must because your unprofitable customers are, to put it bluntly, hurting your business. This extends beyond your bottom line, affecting your relationships with other customers, suppliers, vendors, and more. You need to prevent the issue from escalating and damaging your organization further.

What can you do with nonprofitable customers?

There are two main approaches to dealing with customers who are simply not profitable for you: cutting ties with them and turning them into profitable customers. The latter is preferable, for obvious reasons, but it is not always possible or worth the investment and effort.

The right way to manage unprofitable customers

1. Determine the actual value of customers.

First, you need to know who your unprofitable customers actually are. Start with your profitability analysis, before adding in factors like how much time you’re devoting to each customer and how much you’re getting back in return. Separate your customers into categories, so you know where to focus your efforts.

2. Selectively raise prices.

Do NOT implement price increases across the board. This will effectively punish your profitable customers, and you don’t want to make them pay for your unprofitable ones. Instead, raise the prices for specific services and goods for the customers who are costing you the most, after analyzing where they are having the greatest impact on your bottom line.

3. Evaluate alternatives.

Evaluate external factors that could also be contributing to your customers’ unprofitability. Then, consider how alternatives could play a role. For example, perhaps there are goods of equal value that will be easier to obtain from closer facilities, thereby costing you as a business less money and reducing the negative impact the consumers are having on you.

4. Educate consumers.

It is highly possible some of your consumers don’t know they’re unprofitable. If you take the time to educate them on the ways they can maximize their own value and perhaps rely on alternatives — or eat up less of your time — they may be willing to change their buying behaviors so they can stay on as a customer.

5. Tailor your efforts.

Go back to your individual customer interactions. Is it possible you’re over-servicing certain segments? Should you be taking different approaches on certain bases? Customize your efforts accordingly.

When to drop an unprofitable customer

It is neither ideal nor easy to drop an unprofitable customer. But sometimes, there’s no avoiding it. So, when should you do it? These are situations in which it is most likely the best strategy to end the relationship:

  • The customer is providing absolutely no value to you, monetarily, brand reputation-wise, or otherwise.
  • You’re seeing a clear, long-term downward trend in the customer’s profitability.
  • Your business is changing direction, and the customer has no clear value in the new model.
  • Your business with your high value and best customers are suffering because of your wasted efforts on your unprofitable customers.
  • Your team is suffering because of certain customers.
  • You’re actually losing money on the consumers.

When is customer divestment risky?

The fact is, customer divestment is always a risk. And you must take that risk into account before you make the decision to stop serving a particular consumer or client.

Factors you should consider before taking the plunge include:

  • The referrals the customer has made or has the potential to make
  • The influence they have on other customers or potential customers
  • The value they have offered you in the past
  • The possibility of exclusivity arrangements
  • The effort and resources you will have to put into acquiring new customers and retaining existing (profitable) ones
  • Which competitors they could turn to instead and how this might affect your own bottom line
  • The potential for bad publicity
  • The customer experience they have received so far
  • The longer-term implications of divesting
  • The lifetime value of each consumer
  • How employees could be affected
  • Any legal implications

Managing the divestment process

Once you’ve committed to customer divestment, you will need to begin this delicate process. First, make certain this is the best strategy, taking into account alternative solutions and the possible consequences and impact.

Start by explaining the rationale behind the decision, depending, of course, on the nature of your business and industry. In some cases, the customer may feel that the relationship is no longer benefiting them, either, so this will come as no surprise. In other cases, you may need to drop large customer segments, so it won’t make sense to have private conversations with each one — still, you should make it known that this is happening and why.

If you can, provide assistance to the consumer. You don’t want to burn any bridges, although this may be unavoidable in some cases. Wherever possible, make the transition easier for the consumer, such as by recommending alternatives.

You should have a strategy in place for dealing with unhappy customers. You know that there is a strong likelihood that some consumers will not be pleased with your decision, so you need to have a plan before beginning the divestment process. Being able to recommend alternatives is one way to help ease the blow.

Leave emotions out of it. This is a data-based business decision, not a personal one. Still, recognize that you’re dealing with human beings who will naturally have questions and concerns about why they are not the “right customers.”

In many cases, customer divestment comes as part of the changing nature of the company itself and has little to do with the consumers. Perhaps, for example, a certain territory hasn’t proven profitable for them, and they have chosen to narrow their reach.

Still, the company must consider the consequences of eliminating this customer segment from their base and recognize that there may be consequences for both parties. If you’re no longer able to meet customer needs, who is to say a competitor won’t swoop in and strengthen their own brand in the process? Understand, too, that when you let go of customers, they will rarely care about the rationale behind the decision — they will only focus on the fact that they are no longer able to take advantage of the service.

Still, at the end of the day, this is about maintaining a strong customer base — one that delivers you as much value as you’re delivering them — if not more. So, while divestment is never ideal, sometimes, it is unavoidable. In the long run, you may find this will improve your brand and increase your profit margins, allowing you to strengthen customer relationships with the users who bring you the most value.

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