Center for Services Leadership - Understanding Customer Profitability

Understanding Customer Profitability

The popular business press is catching on to a concept that the CSL has been espousing for years - know the profitability of your individual customers.

In an excellent article in Fortune Magazine ("Will This Customer Sink Your Stock?", September 30, 2002), authors Larry Selden and Geoffrey Colvin point out the pitfalls of one of the most common management mistakes: spending money to bring in customers who actually reduce the value of the firm.

At last, technology is making measuring the profitability of individual customers a much less daunting and expensive undertaking than before. Managers can then use this information to segment the customers by profitability and treat them accordingly. For example, Fidelity's phone system identifies highly profitable customers and puts them in a faster queue so can they be served more quickly. This, of course, lengthens the time that the less profitable - or even unprofitable - customers stay on the phone, so they will tend to turn to less expensive means of contacting the company such as the web.

The authors propose five deadly sins that lead to misjudging the value of individual customers. Do you recognize any of these?

  • Denial- insisting that the differences between customers don't matter or failing to include all of the operating costs into the calculus.
  • The Growth Illusion - adding more and more new customers without knowing what it costs to acquire them.
  • The Illusion of Averages- not knowing which 20% of your customers are providing most of your profits. Remember: The Pareto Principle prevails.
  • Failure to Act - failing to make specific managers fully responsible for acting on customer profitability information.
  • Failure to Drive Share Price - Failing to know how your customers drive your share price and then using that information to drive the price up.

These ideas are right in step with what we teach our MBA students and program attendees when we show them how to evaluate the lifetime value of the customer, segment their customers into profitability groups and evaluate when the customer isn't always right and may even need to be "fired". This is also in keeping with research that Center faculty Mike Hutt and Beth Walker conducted for IBM Global Services which indicated that stronger alignment of their sales force and service organization would result in greater customer profitability.

A related thought from a fellow board member...

"How can you increase profitability without investing additional capital? Influence customer behavior. What is primary to influencing customer behavior? Define who you are going to serve, what they want and how you can get them to visit you more often."

Gary Loveman, CEO & President
January 1, 2003
Harrah's Entertainment, Inc.
From Symposium PowerNotes 2001