In last month's column, I tried to point out that knowing which lines of business you engage in are most profitable, and which are least profitable, is key to creating a sustainable business model for the future.
This month, in Step 3 of the 8 Steps Challenge, I'm going to ask that you apply the same
philosophy to your clients; that is, to implement a system of determining which clients (or jobs) are most profitable and which are least profitable. With this next step it's pretty easy to know that you should seek more of the former and less of the latter, but I'm getting ahead of myself.
As with product and service offerings, if your accounting reports lump all of your clients or jobs together in a single line item called "sales" or "revenue," and lump all of the direct and indirect costs into single line items as well, there is no way to know which type of client or job you should pursue in the future. You're at the mercy of whatever walks in the door.
Applying Pareto's Law, or the 80/20 Rule, we can safely assume that the vast majority of your sales (and profits) are being created by a small minority of your clients. Pareto himself would estimate that 80 percent of your sales and profits come from only 20 percent of your clients.
But which group of clients do you think is tying up most of your administrative time? Which group is calling to question an order or delivery, or to reschedule or enter a change? Which group do your employees get tired of hearing from and even come to dislike? In almost every case the cost to support under-performing clients (the 80 percent) is higher than the cost to support ideal clients (the 20 percent) when measured against the profits they generate.
In other words, most firms spend far too much time and money supporting their worst clients, leaving depleted resources to support their best. Not exactly a prescription for success, is it? And, having the wrong customers causes problems far beyond the obvious financial implications. Negative customers adversely affect employee morale and eat up time that could be spent serving your best clients, or finding more clients like them.
You owe it to your company—and to yourself—to be more discriminating in selecting ideal clients. Ideal clients can be defined as those who:
- Provide or will eventually provide the highest levels of profitability—not just sales;
- Are most likely to grow over time through repeat business and referrals;
- Will be most interested in any new products or services you might offer;
- Are the most professional (or even fun) to work with;
- Require the least amount of effort to generate a dollar of profit.
In my book, Your Business or Your Life: 8 Steps For Getting All You Want Out of BOTH,I use three separate matrix tools to help companies identify their best clients by charting all of their clients from the recent past. While I don't have time to detail all three in this short column, let me introduce the first one, a volume/margin matrix (see chart below).
In this exercise, you would simply denote each of your recent clients (say, for the past five years) by placing a circle in the proper quadrant. Notice that I have used different size circles to approximate the relative annual sales of each client. Without spending days gathering accounting data, you should be able to create a first draft of this almost on gut feel.
Next, can you quickly identify the two quadrants where you would least want to find a large number of clients? And, can you quickly zero in on the common denominator between those two quadrants?
Hopefully you said Q2 and Q3 are the worst quadrants and that the common denominator is "low margin." Small businesses in America simply cannot afford to try and baby sit low margin clients.
By definition, just having a client triggers pre-sales expenses as well as overhead, administrative and customer support, and the potential for problems. If you find your firm bouncing back and forth between profitability one year and break even or losses the next, it is probably due to the quality of your clients.
But, what to do if you find yourself with too many Q2 and Q3 clients? You can't just get rid of, or fire clients—can you? Yes, you can, and it is one of the topics I receive mail about more often than any other. A typical example of these types of letters and emails came from a woman in California who told me that she was terrified when she started "pruning" her client list after using the tools in my book. And yet, she said the quality of her life immediately went up … and her profits soon followed. Humorously, I should also pass on the warning of a woman in one of my workshops who raised her hand eagerly and said: "Be sure and warn them to be careful when they start getting rid of under-performing clients; it feels so good that it's hard to know where to stop!"
You don't have to send pink slips or be rude while setting these money-losers free. I've often advised people to say something like: "Our company has undergone a strategic planning process and has adopted a new way of doing business that we don't think would adequately serve you in the future. We'd like to help you find a new design firm." And then, as someone once joked, give them a list of your competitors!
The two other matrices in my book look at the actual costs to serve clients (and why some are so much more expensive than others), and the issue of momentum; that is, what if a low margin client today is en route to becoming a high margin client tomorrow? These are important issues, but I'm quite confident that even if you only use the Volume/Margin matrix to prune your client list and to establish criteria for accepting future clients, your bottom line will be well served. But once you've pruned your company down to only those high margin clients that you want, what would happen if they were to leave you?
Don't worry, they can't. You're going to lock them in after reading Step 4—Growing Roots—in next month's column.
David Shepherd is president of Designing Profits, Inc.—a company dedicated to the financial success of A&D firms. For information on conferences, business schools, the best practices network and other services, please visit www.designingprofits.com.