Ask most finance teams which customers are their least profitable and they will pull up a gross margin report. It is a sensible place to start, and it is usually the wrong answer.
Why gross margin misleads
Gross margin tells you what a customer pays above the cost of the goods. It says nothing about everything else the customer asks of you: the orders you process, the lines you pick, the trucks you send, the service calls you take, the sales visits you make and the time you wait to be paid.
Two customers with the same margin percentage can be worlds apart once that work is counted. One orders a full pallet once a month. The other orders a few cases twice a week, wants delivery by the morning and calls to check where it is. On the margin report they look identical.
Signs a customer costs more than it looks
You do not need a full analysis to know where to look. These are the usual warning signs:
- Small, frequent orders. The same volume spread over many orders means more handling, more picking and more deliveries.
- Delivery demands. Rush orders, narrow delivery windows and extra drops.
- A heavy load on your service team. Changes, queries and complaints that nobody invoices.
- Terms nobody priced. Long payment terms, special packing, consignment stock, returns accepted without question.
- A price set years ago. The customer's buying pattern has changed. The price has not.
None of these makes a customer bad. They are only a problem when the price does not reflect them.
What to do with the answer
Finding an unprofitable customer is not a reason to lose them. Most of the time the better options are about revenue, not exits:
- Reprice the customers whose price no longer covers the service they get.
- Charge for the extras they use most, such as rush delivery or orders below a minimum.
- Change the service level where the customer would rather pay less and receive less.
- Grow the customers that already pay their way, and use what they have in common to find more like them.
Start with one customer
If one customer comes to mind as you read this, put it through our free cost-to-serve calculator. Enter its revenue, margin, orders and deliveries, and in about a minute you will see its profit after the cost of serving it, and the price rise that would close the gap.
Doing the same for every customer, with your own costs instead of estimates, is what our Revenue Opportunity Assessment is for.