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Profit Improvement Report Customer Elimination: Brilliant Strategy or A Fool���s Game? Before you chop, consider the costs that won���t disappear just because the unprofitable customer does. By Dr. Albert D. Bates Distributors have been concerned about unprofitable accounts for nearly 50 years (the first rigorous analysis of the topic, Marketing Productivity Analysis by Charles Sevin was published in 1965). The inescapable conclusion then, as now, is that distributors lose money on about one-third of their customers. Until fairly recently the unprofitable customer concept was simply that, a concept. With the advent of more sophisticated technology and computer programs (especially Excel) there is now the ability to precisely measure which customers are and are not profitable and why. Alas, such sophisticated analysis has frequently led to automatic, ham-handed efforts to deal with the unprofitable customer problem by simply eliminating large numbers of customers. This report will suggest that customer elimination programs have the potential to do far more harm than good. It will do so by exploring two aspects of the customer profitability relationship: n Customer Elimination Economics ��� An examination of the sales, margin and expense impacts associated with eliminating customers. n Customer Strategies ��� Some specific suggestions for ensuring that the firm drives maximum profit from its customer set. Customer Elimination Economics Calculating customer profitability is a relatively simple process. Improving profits based on that customer analysis is much more complicated. Measurement is a lot different than improvement. In determining customer profitability it is necessary to tie costs to customers in a meaningful way. For example, if the firm���s total delivery costs are divided by the number of deliveries, it is possible to approximate the cost of making a delivery. This basic calculation can be modified for distance, size of the delivery and the like, but the underlying process remains the same. After that, the cost per delivery is applied to the number of deliveries made to a specific customer, and the total delivery expense for that account can be estimated. Similar approaches can be taken for other cost categories, such as sales commissions, order picking, and returns processing. In almost every instance, about 40 percent of total costs can be assigned to specific customers. These are what are referred to as direct costs. The remaining 60 percent are indirect costs. They are incurred for the overall benefit of the firm and cannot be traced to individual customers. These include the salaries of the administrative staff, rent and utilities associated with the warehouse and a wide range of other overhead expenses not associated with a specific customer. When customers are eliminated, the direct versus indirect cost analysis is no longer applicable. It must be replaced with a different managerial accounting concept with cumbersome titles ��� escapable versus inescapable costs. Simply put, escapable costs are those that will go away when the customer is eliminated. The inescapable costs will not. To make matters more complex, some costs are partially escapable and will merely be reduced. From an expense perspective, 20 percent of the expenses 62 | www.cedmag.com | Construction Equipment Distribution | January 2013 62_Bates_Profit_Feature_EB.indd 62 12/21/12 1:29 PM