Making Money with Small Customers: Defeating the Profit Drag

Posted on

When managed properly, small customers can be served profitably. Read excerpts of an article authored by SPA President, David Bauder, that was published in Modern Distribution Management. The article focuses on how important it is for distributors to use a scientific pricing process to make sure small accounts are priced at reasonable premiums to offset their higher costs to serve.  

“They treat the bottom tier as if it were nonexistent, not worth understanding, not worth managing.”

Small customers are an important source for learning how to serve myriad market needs. They diversify the customer base (and associated risks of customer concentration) and, in aggregate, improve pricing leverage with more powerful customers and vendors. They also can represent a leading indicator of a company’s sales and marketing vitality, its operational capabilities and, more fundamentally, the validity of a company’s value proposition and competitive positioning. A healthy business will likely have a continuous flow of small customers. It’s exciting, at a gut level, to attract new small customers.

So, why do so many executives feel ambivalent about small customers? If you ask them to describe their customer base, they almost always start off by using the 80/20 rule and tell you about everyone in the top 80 percent and nothing about those in the bottom 20 percent. They treat the bottom tier as if it were nonexistent, not worth understanding, not worth managing.

“Sales reps often misunderstand the true potential of small accounts, labeling them “high potential.”

Sales reps often misunderstand the true potential of small accounts, labeling them “high potential.” SPA’s research shows that in any given year, 93 percent of accounts stay in the same size class the following year. Furthermore, 97.5 percent of small accounts in any given year remain small the next year; 4 percent move up one quintile; 1 percent move up two quintiles; 0 percent move up three or four quintiles.

The upward mobility statistics are modest but better for other customer size quintiles. The biggest opportunities seem to be concentrated in retaining and/or expanding the loyalty of the next two quintiles up in size; in these groups, there is a 30 to 40 percent probability that they will shrink by one or two quintiles from one year to the next. Sales efforts should be prioritized accordingly.

“30 percent of small customers in any given year pay below-market price for their basket of products. ”

The tendency of small customers to receive lower prices cannot be overstated and shouldn’t be ignored. SPA’s research shows that 30 percent of small customers in any given year are paying below-market price for their basket of products, reducing overall margins by 3.5 percent to 5.5 percent. To measure the margin impact, we compare actual margin to what it would have been if customers had paid true market price and/or size-adjusted market pricing.

Small customers often get lower prices for several reasons. First, the small dollar impact of large pricing concessions to small customers doesn’t trigger the financial alarm bells that would result if the same percentage concessions were given to larger customers. This is called financial death by a thousand small price cuts.

“Most importantly, make sure small accounts are priced at reasonable premiums to offset their higher costs to serve.”

The key to happiness with small customers is complex yet simple. Refrain from exerting scarce organizational resources on small accounts that have little or no potential growth rates. Point them to methods of service (inside sales, e-commerce, etc.) and vendors that are appropriate to the size of the opportunity. Incent the sales team to reduce churn rates for mid-size accounts and to identify and deliver profitable small accounts.

Most importantly, make sure small accounts are priced at reasonable premiums to offset their higher costs to serve. Make sure the pricing process and tools reliably produce this outcome.

Click here to read the complete article. [a subscription is required]

Follow SPA

To easily keep up with the latest SPA announcements, events and resources you can subscribe to our Strategic Pricing Pays blog or follow us on LinkedIn or on the following major social media channels and file sharing platforms: Twitter, Google+, Facebook, SlideShare, and YouTube.

We also encourage you to join the Strategic Pricing discussions in our LinkedIn group and to sign up to receive our Strategic Pricing Newsletter by clicking here.

Post a Comment

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s