Why well established business owners need to look beyond sales figures when judging the value of their customer relationships.
Most well established business owners have a fairly good understanding of who their biggest customers are. Ask them to name their top five accounts and they’ll usually be able to tell you without looking at a report. They’ll know roughly how much each customer spends, how long they’ve been dealing with them and, in many cases, the people involved in the relationship. That’s useful knowledge, particularly in a business where personal relationships have been built over many years.
What I’m less convinced about is whether owners know which customers are making the strongest contribution to their business. There’s a big difference between a customer who generates a substantial amount of turnover and one who delivers a healthy, dependable commercial return. The two can be the same, of course, but I wouldn’t automatically assume they are.
It’s an important distinction because a business can become very busy looking after customers who aren’t necessarily contributing as much as everyone believes.
The difference between sales and contribution
Imagine two customers who each spend £500,000 a year with your company. On the monthly sales report they look broadly similar, and both would probably be regarded as important accounts. But when you examine how the relationships actually operate, the picture can be quite different.
The first customer places regular orders, provides clear instructions, pays within the agreed terms and generally operates within your normal service arrangements. There are occasional problems, as there will be in any commercial relationship, but they’re dealt with sensibly and don’t require an unreasonable amount of additional work.
The second customer spends exactly the same amount but operates very differently. Orders are frequently changed, delivery requirements are more demanding, additional support is expected and invoices regularly become the subject of discussion. Senior managers may find themselves involved in matters that should ordinarily be handled much further down the organisation.
Both customers generate £500,000 in sales, but I would be very surprised if they produced the same financial contribution once all the additional costs were properly understood.
And that’s where I think most businesses would benefit from looking a lot more closely at the detail of their business relationships.
The costs that don’t always appear on the customer report
Most companies have a reasonable understanding of the direct costs associated with supplying their products or services. They know what the materials cost, what labour is involved and roughly what gross margin they expect to achieve. Where things become more complicated is understanding the additional cost of dealing with individual customers.
Management time is a good example. If a customer regularly requires the attention of the managing director, operations manager or finance team, that time has a cost even if nobody records it against the account. The same applies to repeated changes, urgent deliveries, additional administration and work that has to be corrected because requirements weren’t properly agreed in the first place.
I’m not suggesting every business should introduce an elaborate accounting exercise to allocate every minute of an employee’s time to individual customers. That would probably create more work than value in many SMEs. But I would want enough information to identify where particular relationships are consuming significantly more resources than expected.
There’s also the question of what that additional work prevents the business from doing elsewhere. If your best people are constantly resolving problems for one demanding account, they’re not available to develop other customers, improve operations or concentrate on more profitable opportunities.
That opportunity cost can be just as important as the direct expense.
Long-standing relationships deserve attention, not automatic protection
One of the strengths of a good established business is the relationships it develops with customers over many years. I wouldn’t want to lose that, and I certainly wouldn’t advocate treating customers as nothing more than figures on a spreadsheet.
Relationships matter. Trust matters. And there are perfectly good commercial reasons for providing additional support to an important customer, particularly where the relationship offers long-term opportunities that justify the investment.
But I do think businesses need to be careful about allowing historical arrangements to continue indefinitely without questioning whether they still make sense.
A customer may have received particular terms because they were exceptionally important to the company ten years ago. Perhaps the business was smaller at the time, needed the work or was entering a new market. The arrangement may have been entirely sensible when it was agreed.
The question is whether it’s still sensible today.
Businesses change, their costs change and their capacity changes. Customers change too. An arrangement that was mutually beneficial several years ago may now be considerably more favourable to one party than the other.
There’s nothing unreasonable about reviewing that position. In fact, I’d regard it as part of managing a commercial relationship properly.
What would I want to know?
If I were reviewing the customer base of an established SME, I’d start with the accounts that represent the greatest proportion of sales and then look beyond the headline figures. I’d want to understand the actual gross profit generated, the payment behaviour, the resources required to service each account and whether the relationship is becoming stronger or weaker.
I’d also want to understand why the customer buys from the company. Is it because the business offers something genuinely valuable and difficult to replace, or has the relationship become largely dependent on price and habit?
That tells you something about the quality of the relationship and the strength of the company’s position in its market.
I would then look at the customers who are particularly profitable and straightforward to deal with. What do they have in common? Are they concentrated in a particular sector? Do they buy certain products or services? Do they value aspects of the company’s offering that other customers don’t particularly appreciate?
The answers might help the business become a whole lot more selective about what work it pursues in future.
This isn’t about getting rid of every demanding customer. Some of the most commercially valuable relationships require considerable effort. What matters is whether the return justifies that effort and whether the business has made a conscious decision to support it.
Building a stronger business
Customer profitability matters for reasons that go beyond the immediate financial result. A company that understands where its profits come from is in a much better position to make decisions about pricing, sales priorities, capacity and future investment.
It can also make the business more resilient. If management understands which customers create genuine value, so that it can concentrate on protecting and developing those relationships rather than simply chasing additional turnover.
And for an owner thinking about the longer-term value of the company, the quality of the customer base is an important consideration. Dependable, profitable relationships supported by sensible commercial arrangements are considerably more attractive than sales that depend on constant concessions and disproportionate management attention.
I think there’s a useful exercise here for any established business owner. Take your ten biggest customers and look at them from a different perspective. Instead of ranking them purely by turnover, consider the contribution they make after allowing for the real cost of serving them.
You may find the ranking changes.
And you may discover that some of the customers you’ve been concentrating on aren’t necessarily the ones that deserve the greatest attention.
John F. Kettley
Helping established business owners build profitable, valuable businesses that create wealth, choice and freedom.