Adapted from content excerpted from the American Express® OPEN Small Business Network
The 80/20 rule – that 80 percent of your sales come from the top 20 percent of your customers – applies to most small businesses. Nurturing that precious 20 percent means focusing your marketing programs on the customers who drive your company’s profitability. A laser-like focus on these high-profit buyers also prevents you from expending too much effort on lower profit customers.
Remember that profitability does not necessarily correlate with the amount of money a customer gives to your business. In many businesses, smaller sales can be highly profitable, while larger sales can cost the company a lot to administer or deliver, and therefore have a smaller profit margin.
Use the tips here to unearth your most profitable customers.
Calculate acquisition costs
To assess customer profitability, you need to determine how much it costs your business to attract each customer. Many small businesses will be able to get away with a cost of sales analysis that is much simpler than what larger companies use. Keep in mind that the cost of sales numbers produced through these calculations are averages, to be used for rough evaluations of your customer base.
To conduct a simple analysis, first review the effort involved in closing a typical sale. Be sure to include expenses like a salesperson, direct mail, Web site development or other advertising costs. Estimate the total cost of your outreach and divide it by the number of sales you close annually to do a “quick and dirty” analysis.
Calculate cost of customer service
It is important to track your customer service expenses to measure how profitable your current customers are. The equation is similar to the cost of sales analysis. Apply costs for service-related items such as order taking personnel, project manager salaries and delivery of your product or service to each customer. Estimate the average cost of servicing each customer by dividing by the number of customers you serviced during the year. If you need help determining key service expenses in your industry, ask your accountant for industry standards. Keep in mind that the cost of service numbers produced through these calculations are averages, to be used for very rough evaluations of your customer base.
Create a high-potential profile
With the two figures above and the revenue that each of your customer provides, you can determine a rough sense of individual customer profitability. You can use this information to develop a profile of your high-potential customer. Look for common characteristics and behaviors. Do they fit into specific demographic or geographic categories? Do they have certain shared attitudes or values? Do they make their buying decisions in a similar way? This profile will help you develop the most effective marketing programs to reach these targets, extend their value to your company, and attract more high-profit customers.
Some businesses might want to go a step further and develop a customer potential pyramid – a three-segment hierarchy that breaks out the company’s high-potential, medium-potential, and low-potential customers. The purpose of this profile is to look for marketing tactics to migrate customers into the high-profit categories.
Reallocate efforts around least profitable customers
In support of your focus on the top 20 percent of your customer pool, you should make an effort to not attract unprofitable customers. Review your records for those customers who cost you valuable time and money and create a profile of them in the same way you built a high potential profile. To the degree that you can, be sure that your marketing programs exclude these customers, to keep you efficient and profitable.
Since every relationship is an important link to other customers, try to avoid alienating anyone by telling them you don’t want their business. Instead, just avoid focusing resources on reaching them.
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