How can you get more of the top-paying customers and make your business more profitable? In today’s guest post, David Worrell shares simple steps to creating a customer segmentation strategy that increases your profits.

These days, being a “customer focused” business is expected — even taken for granted.  Companies large and small brag that they will bend over backwards for each and every customer.

Unfortunately, that’s not always a profitable strategy.

Like it or not, all customers are not created equal. And if you are treating them all the same, you are not only wasting money but also potentially missing the chance to make higher profit sales.

If you don’t know one customer from the next, wake up and smell the segmentation strategy.

In almost every business, just 2F percent of customers account for 80 percent of profits.  And frankly, many companies would be better off if they simply did not have to serve the bottom 80 percent at all!  (That’s known as the “Pareto principle” or the “80/20” rule…I didn’t just make that up.)

But before you go out and fire 4 of every 5 of your accounts, take a closer look.  By understanding the profitability of each customer segment, and adjusting your operations accordingly, you can keep the customers and maximize profits.

Sort the Wheat From the Chaff
How do you create customer segments? Start by creating a list of all your customers.  Next to their names, write the total money they spent with you this year.  (You could use more complex indicators like gross margin, but just “annual sales” is a pretty good indicator of the customer’s importance.)

Now rank order the list by the sales amount.  How much difference (variance) is there between the top-spending customer and the bottom-feeders?  If you are like most companies, there is a big difference between top and bottom, but you’ll probably have customers that fall over the entire spectrum.

To make a big list of customers easier to work with, divide your customers into 5 groups – called quintiles (or simply segments.) In the first group, or segment, will be those at the top of the list that spend 81 percent to 100 percent of the biggest spender.  Don’t worry about how many companies are in each quintile, only on the amount they spend with you.  When you are done, you’ll have 5 groups:

  • Quintile #1:  80 percent to 100 percent of maximum spend
  • Quintile #2:  61 percent to 80 percent of max spend
  • Quintile #3:  41 percent to 60 percent of max spend
  • Quintile #4:  21 percent to 40 percent of max spend
  • Quintile #5:  0 percent to 20 percent of max spend

Take Action
This kind of quintile analysis can be useful to strategy, marketing and budgeting.  Now that you know the dollar value that each customer spends, you can adjust your entire business strategy so that each quintile becomes more profitable.  In effect, you are going to make your business “respond” to each customer in a way that reflects their true value to the company.

Start with these 5 steps to respond more appropriately to each customer:

  1. Know who is who.  Every person in your organization should be able to tell which segment a customer falls into.  Put notes in your CRM system, or simply make a list on the wall!  You can’t respond appropriately without knowing who’s who.
  2. Adjust your promotional budgets.  Rather than send all your customers a gift basket at Christmas, you should probably minimize what you spend on the smallest customers, while you really go all out for the big guys.
  3. Adjust your pricing.  You should certainly charge the small guys slightly more than the larger accounts.  This will help balance the profitability of each quintile, but it will also encourage small customers to spend more to get the discount.
  4. Adjust your sales.  Take a close look at the companies in the top 2 quintiles. These are your best customers. How can you get more customers like this?  What makes them different?  Make sure your sales people are targeting more great prospects and fewer that will likely fall into the 4th and 5th quintile.
  5. Adjust your messaging.  Make your marketing message fit the unique perspective of each quintile.  Don’t send the small fries the “Big Sale” notice, and don’t send the big guys a “Get to Know Us Better” message.  Focus on marketing messages that recognize the relationship you have, and encourage the accounts to move up in your rankings.  If you spend $1 each month promoting to the largest customers, you should spend just 10 cents advertising to the smallest customers.

If you follow this prescription long enough, you will start to see more “low-spending” customers bubble up and spend more.  You may also find that some of the small fry stay where they are or simply drop out.  That’s OK.

Grow Profitably
In fact, at some point, your business will be so much more profitable, that you may want to “fire” those customers who are left in the bottom quintile.  Adjust your minimum order or pricing policies until these companies buck up or drop out.

To survive and thrive, a business must make a profit from every customer.  Take the time to really understand who your best customers are – and to adjust your company to respond appropriately – and you’ll see profits begin to increase.

David Worrell offers finance and strategy advice to small business owners at www.RockSolidFinance.com.   Contact him at David@RockSolidFinance.com.

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