Sales Strategy
Is This Client Worth It? How to Analyze Client Profitability | January 06, 2016 (1 comment)
Campbellsport, WI—I spend a lot of time thinking about the balance between cultivating customers and customer profitability – both for my own business, and for my clients. For every type of B-to-B business – whether you sell products or services – it is critical to understand if your clients are actually worth it. And for jewelry designers faced with the constant request to provide memo goods, it’s business life-or-death.
I have long taken issue with the statement the customer is always right. It was stupid when it first came out, and it’s still stupid today. I understand that someone was trying to make a point about how we are supposed to treat others with dignity and respect, but the real intention was distorted the moment those words were strung together in a sentence.
Small businesses, micro-businesses, and solo-preneurs tend to think that a new customer – any new customer – is the point. They get so excited about the prospect of cash and exposure that they fail to analyze the potential profitability of the source of that cash and exposure. I can personally attest to the fact that invoices paid do not necessarily equate to client profitability. I have learned walk away from accounts that seem like a big deal, because they steal focus, money, energy, creativity, or even brand reputation from my own organization. Even a big client can be not worth it. But this is a difficult business truth to accept for a small business that is trying desperately to cultivate sales.
Let’s take a brief look at whether or not to take on memo accounts, and then I’ll show you how to analyze any type of customer for potential profitability.
Should I Open Memo Accounts? I am often asked by jewelry designers if they should take on memo accounts. And my answer is pretty consistent: Mostly no, with rare exceptions. The exceptions are easy to list: It’s reasonable to take on a memo account if it will deliver on four out of five of the following points:
- Provide you with genuine credibility and brand exposure (i.e., “So-and-so carries my work,” which leads to other retailers saying WOW and buying in). The ideal memo account should be a door-opener.
- Is an account that is known to do a terrific job of promoting and selling designer work – even if it’s on memo.
- Is an account that is known to pay its bills promptly.
- If you can afford to stock that account with the amount of inventory they need without going into debt in the process.
- If you can afford to service that account without it creating costs (in you and your staff’s time and attention) that take you away from other more profitable opportunities.
There. That’s the checklist to use when considering whether or not to take on memo accounts. If a potential memo account can’t be a hit on 4 out of 5 of the points above (pick any 4, but no less than 4), then it probably isn’t worth your investment.
Why do I say this? Because everything you do as a small business (or micro-business, or solo-preneur) must turn a profit. When you self-fund a business, the only money you have to fund growth is the money you put back into the business. You can’t afford to spend the time, attention, or investment-in-inventory on accounts that aren’t putting profit back into the business – and by that I mean profit sufficient to help you continue your self-funding.
I can already hear some of you thinking, “But I can’t get into any accounts without memo!” And I know that’s true. Jewelry retailers are notoriously hard to get into – the majority of them want jewelry designers to pay to play. If this ultimately turned into a profit-generator for most jewelry designers, I wouldn’t be writing this blog. But it doesn’t. So we’re going to spend a few minutes talking about how to analyze the profitability of a client.
Now Let’s Analyze Your Client Profitability. When you take on a new account, it’s imperative that you calculate the costs, time (which is, of course, a cost), investment (inventory, up-front development work, shipping, etc.), financial return, and amount of time it will take to achieve that financial return. This is easier than you might think.
I’m going to explain all of this below. I’ve also prepared a spreadsheet for you to use – available as an Excel workbook. Click this link to download your workbook, and work along with me.
Start by Understanding Your Fixed Costs. (To complete this section, start by inputting your PROJECTED REVENUE in the “Anticipated Revenue” tab of the workbook. Then go to the “Fixed Costs” tab in the workbook.)
For every project you do, you have Fixed Costs. The most obvious Fixed Costs to a product seller are the cost of the inventory the client wants you to sell them – or “loan” them if it’s memo they’re asking for. If you are required by the client to pay shipping, those costs will be fixed as well. Fixed Costs would also include any unreimbursed travel you are required to make to get the client set up or to provide training, and would also include any displays, packaging, or marketing materials that you will provide.
For service providers, Fixed Costs can include the cost of the bidding process, the cost of setting up communications tools, training for both the service provider team and for the client, travel, and support materials. All the time, fees, and expenses incurred in the winning of a client and in launching them –whether it’s to sell your goods or use your services – are Fixed Costs.
Formula: Cost of your time + cost of employee and contractor time + cost of inventory (one year) + cost of unreimbursed travel + cost of unreimbursed shipping + cost of marketing, training, and marketing materials + any other required initial expenses = Fixed Costs.
Analyze Variable Costs. (To complete this section, go to the “Variable Costs” tab in the workbook.)
Variable Costs are the costs of managing a customer after start-up. For your analysis, you need to figure out the Variable Costs of the new client in the course of the first year.
The first variable cost you should calculate is the amount of non-production time you and your employees will likely spend managing the client. This includes time spent managing orders, special orders and special requests, in meetings, dealing with revisions and redirections, swapping out inventory, reconciling memos, invoicing, and the amount of time you spend calling them to collect overdue invoices. You should start by analyzing what the average client costs you in time to do these things, then use any market or peer information you have to determine if the client is likely to be lower-maintenance or higher-maintenance than an average client.
If the client requires you to participate in promotions throughout the year, such as trunk shows, annual client catalogs or calendars, the expenses and time associated with these projects are also Variable Costs. Coop advertising should also be included, and you should calculate the amount of coop based on the amount of Projected Revenue.
Some computer software will result in added Variable Costs, such as a CRM that charges you by the client, or an image management system or project management software that you pay additional fees for adding new users or clients. Make sure you figure the incremental cost of all your business management tools, because those costs can add up fast, and you want to make sure you understand the costs relative to your clients. Otherwise, you risk overestimating how much each client is worth.
Formula: Cost of your time to manage this customer over first year + cost of your employee time to manage customer over first year + incremental costs to any business software tools + unreimbursed service costs + coop advertising costs + any other Variable Costs not listed here = total Variable Costs to manage client.
Figure Out the Break-Even Point. (To complete this section, go to the “Break-Even Point” tab in the workbook.)
Your Break-Even Point is the point at which the client has paid for itself. It is not the same as profit. Profit is what comes after the Break-Even Point. To calculate the Break-Even Point, you add up the total Fixed Costs of start-up, the total inventory costs for the first year, and the total Variable Costs per year. That is the cost you must recover in order to start turning a profit.
What if it’s negative? Then increase your Projected Revenue amount – in increments – to see at what level of sales that client would have to perform in order to be profitable. If the amount of sales required is unreasonable for that client, they’re not a good risk – with one exception: If you can demonstrate that they will produce significant profits in year two and beyond, and if your business can handle the strain of investing in that client for a full year before getting a return, the client may make sense. However, if you go into any level of debt in order to finance the customer, make sure you include the costs of that debt (credit card or loan fees and interest) in your Variable Costs for the customer for however many years you carry the debt.
Formula: Projected Revenue – non-inventory Fixed Costs – inventory costs – Variable Costs = Break-Even Point.
Determine the Contribution Margin. (To complete this section, go to the “Contribution Margin” tab in the workbook.) While most small business owners are reasonably good at calculating costs of inventory and whether or not the sales of products are creating a profit, relatively few small business owners know whether or not a client is profitable. That’s because they don’t calculate the Contribution Margin.
It’s tempting, when you think about taking on a new client, to get excited about every sale. Emotionally, sales are fun. But rationally, we know we incur many additional costs in our effort to close the sale. Contribution Margin is how much money you have to cover your Fixed Costs once the Variable Costs have been taken into account. To get this amount, you subtract your total Variable Costs from the expected revenue for the client. By analyzing the Contribution Margin of each client, you gain insight into whether or not the client is producing a profit beyond the profit margin of the goods or services you sell them. This is essential insight, because a high-maintenance client may produce acceptable – or even very good – sales, but still be a money-loser.
Formulas:
- Contribution Margin: Projected Revenue – total Variable Costs = Contribution Margin.
- Profit: Contribution Margin – First Year Inventory costs – First Year Non-Inventory Fixed Costs = Profit.
Ongoing Profit Analysis. (Use the “Contribution Margin” tab in the workbook. The section is “Subsequent Year Contribution Margin.”)
Finally, you must ensure that each customer is returning a reasonable amount of profit after the first year. Many businesses will perform strongly for a few years, then drop off in subsequent years. This is particularly true when selling to retail establishments that have a style or fashion component, but it’s also true for service businesses that work with clients who eventually will develop some of those services in-house. Once client revenue drops below a certain level, they will stop being a productive client for you. When that happens, your time will be better spent elsewhere.
Formula: Projected Revenue – Total Variable Costs = Contribution Margin. Contribution Margin – Projected Inventory Cost = Profit.
While you may love what you do, you’re not in business purely for fun. You need to turn a profit, and if you’re not turning a profit, then either A) you’re in such a financial position that you can afford to do your hobby full time, or B) you’re going to eventually burn out (both personally and as a business). Invest the hour or two that it may take you to completely understand this concept. Use the spreadsheet I provided to see how easy it is to calculate these numbers. And learn to identify which clients are worth serving and which are not.
Don’t be afraid to face the truth about client profitability. If you have a preponderance of clients who aren’t worth it, you need to know that. That knowledge will give you the impetus you need to find other ways of selling and other types of clients to sell to. A business only dies when its owner stops feeling the motivation to find new ways of selling and new clients to serve. The time is going to go by either way. Wouldn’t you prefer to be earning a comfortable living at the other end of that passage of time?
Andrea Hill owns Hill Management Group, LLC, with the brands StrategyWerx, MentorWerx, and SupportWerx; providing strategy consulting, professional development, branding, and marketing services to small and mid-sized businesses.