Category: Business Models

Managing customer profitability

As business models and contexts have evolved, companies have had to shift their view from ”by all means” customer retention to a new type of approach to customer relationship strategies: divestment. This was considered unacceptable in the past, due to customer acquisition cost and the race for market share. However, due to a different approach to segmentation and the technologies that aid customer value return tracking, divesting has become viable when the strategy is to focus on the right kind of customers.

Divesting is appropriate when a customer or a group of customers generates more cost than the value the company extracts from the relationship, deeming the entire business contract unprofitable. The downside, of course, is loss of market share (to competitors), reputation and distrust among remaining customers (sensing the potential of being divested next), if the process is not done in a correct way. What’s more, a smaller customer base means that the financial risk increases, due to the smaller spread base, if the company radically divests. Companies must also not overlook the legal and ethical implications of divestment, depending on the customer relationship and on the type of commercial contract they have in place at the time of the divestment.

Even with the many risks of divestment, as described above, a company must consider divestment if a specific customer segment is either unprofitable to begin with or if it has a significantly lower profitability, compared to the rest of the customer base. A shift it business strategy or a capacity constrain could also be the basis of a divestment strategy. What’s more, the company must also consider the morale of the employees directly involved with the divestable customer segment, as they become less motivated if their work does not produce the desired profitability, potentially affecting bonuses or promotion opportunities.

In order to correctly implement such a divesting strategy, the company must take certain steps in order to precisely determine the customer segment that requires a rebalance in the commercial relationship. The first step should be a thorough reassessment of the current customer and their financial potential (future spending, potential for growth). Then, the company must try to educate the unprofitable customers, manage expectations in order to restore the equilibrium. Of course, this is easier for B2B businesses than in B2C cases, as the volume difference requires different approaches and their inherent costs (human capital, communication budgets etc.). The next step is actually renegotiating the entire value proposition, in an effort to balance the value invested vs. customer value return. Once renegotiation has been attempted and failed, another approach would be to migrate the current unprofitable customer segment to other partners, providers or channels, retaining a portion of the value and keeping the customer in the business ecosystem, but with a reconfiguration of the service level. If this also fails, then the only option left is to divest, but in a way that minimizes negative fallout, through appropriate personal communication.

The direct effect of the internet and the entire technological revolution is that customers are becoming more informed, active and connected. This is a fact to be considered when devising the marketing philosophy of the company.
Companies must now migrate from the traditional, product-manager, approach, where marketing was a one-way, impersonal process and the segmentation, pricing, promotion and mass media communication needs was activated a posteriori. The new approach is a customer-manager one, focusing on multi-way communication and long term relationships, through direct interaction, data collection and analysis and solution tailoring in order to maximize the value extracted from every customer relationship.

This new approach requires the company to rethink its organizational structure, transforming the marketing department into the customer department, where a customer centric Chief Customer Officer constantly seeks to find out the real wants and needs of the customer. He is accountable for customer profitability via the CLV (customer lifetime value), customer equity and customer equity share metrics, reports directly to the CEO, pushes marketing leaders to interact with customers as often as they need and provides a framework for free information flow throughout the organization to facilitate data interpretation.

Managerial implications

But what are the general implications and potential improvements or spinoffs of the customer divesting strategy as an approach to maximize customer equity share and overall profitability?

In the effort to grow one’s business, some managers overlook the segmentation profitability analysis and tend to compare their success in respect to the overall customer pool and the company’s profitability as a whole, blocking potential boosts in profitability by focusing on just the high value customers. If this high value approach is not possible in the early stages of business development, managers must take into consideration the deployment of a flexible, fluid customer business relationship, in order to have the leverage needed to increase value as the relationship strengthens.

They should be able to monetize more service components according to load (charge the high maintenance customers more) and offer premiums to customers who are less cost intensive (never call and pay on time). This means that companies must allow a consultancy approach to business, rather than just a product/service delivery, diversifying revenue streams. This type of mixed approach also diminishes the risk of expectations misalignment, as customers know from the beginning what they get for what they pay (one time – product, periodic or on demand – post-sales services), influencing pricing policies company-wide.