Customer Patterns: The Profitability Effect

Ignorance of customer behavior is the greatest strategic risk facing businesses today. Every day they vote with their time, with their word of mouth, with their money and with their allegiance, for the business designs that best serve their evolving priorities. The results of their shifting decisions are value creation and value destruction. Customers determine profits.

Profit Shift MicrosegmentationPower Shift Redefinition

Profit Shift

In many markets, not all customers are profitable. An examination of true pricing and the true costs of serving customers may reveal that a company is actually losing money on many customer accounts. The shift from "all customers are profitable" to "many are not" has been triggered by declining gross margins and increasing variability in the cost to serve customers. Suppliers will be rewarded for being much more rigorous in:

  1. Measuring current and potential profit customer by customer
  2. Selecting the promising customers, and
  3. Choosing how much to invest in those customers.

Customer profitability is a relative concept. When a firm's capacity utilization is low, even a "bad" customer is valued because the incremental volume helps to cover fixed costs — in the short term. For the long term, however, the fundamental issue remains: either replace the "bad" customers with good ones, or reduce capacity, or do both. The key to reversing this downward spiral into unprofitability is the ability to continuously resegment the customer base. A customer profitability system can reverse the process and enable a company to exploit profit shifts to its advantage. By developing an accurate and dynamic model of how profitability varies at the individual customer level, a company can select and develop strategic customers who yield the greatest long-term value.

What do you do when you're in a Profit Shift pattern?

Invest the time and effort to build a customer profitability system and update it regularly.
Change pricing, service levels and investment levels accordingly.

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As an industry matures, growing customer heterogeneity and increasing customer sophistication change the fundamental nature of the market. Early in an industry's evolution, most customers are well served by a standard product. As these customers become more familiar with the product and apply it to different needs, their requirements begin to move in many different directions. Suppliers may then begin to modify the product to better serve different customer groups.

One outcome of good segmentation is a larger market. Customers will pay more for a product or service that is well suited to their needs. In this new environment, the company that segments best and delivers a message that best addresses customers' needs, wins. Three market conditions must exist before the microsegmentation pattern can succeed.

  1. There must be an increase in customer heterogeneity.
  2. Customer sophistication must escalate. As customers' expectations for greater functionality or personalization of a product or service increase, they will demand more offerings and more choices.
  3. When both of the conditions above are present, a third market condition — technological change through systems infrastructure — will allow a company to service multiple segments efficiently. The Internet and advanced database technology, particularly with the targeting capabilities of intelligent agents, represent tremendous potential for this effect.

What do you do when you're in a Microsegmentation pattern?

Cut the deck finer and finer. Identify the most profitable slivers and offer them perfectly tailor-made options.
Then build a fence around them so that your competitors find them prohibitively expensive to acquire.

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Power Shift

The distribution of power between sellers and buyers influences every negotiation or transaction and profoundly influences the allocation of profits and value. Significant power imbalances can translate quickly along the value chain. Several factors can trigger the power shift pattern:

  1. Customer consolidation
  2. The formation of professional purchasing groups that bring tremendous expertise to the purchasing process
  3. An overabundance of information on suppliers' costs and performance
  4. Suppliers' lack of differentiation in either the products offered or the business models used to serve customers.

When a company's customers have gained the upper hand, there are a few options available:

  1. Out-concentrate the customers. If key customers are more consolidated than you, then consolidate back, merging to ensure that customers can't do without your portfolio.
  2. Change the offer, change the customer.
  3. Leapfrog the customer. Companies can vault past their customers via a strong end-user brand, direct channel initiatives and innovative strategies to minimize their current customers' response.
  4. Become the customer. The most radical move of all is to buy your largest customer. To generate value, make this move just before power starts shifting to customers, not after it has progressed. Purchasing of a distribution channel lets you join rather than fight the rise in customer power.

What do you do when you're in a Power Shift pattern?

Rebalance the power equation. If that move is impossible, redefine the customer.

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Sometimes the only avenue is to create a fundamental redefinition of the customer. This is true when your company is faced with an irreversible power shift to your buyers, when it has reached a plateau in profit grown, or when your industry has run into a saturation problem in its customer base. Some market options include:

  • Different segments — Look at your current customer base and rethink segment potentials.
  • Different value chain participants — Your traditional customer may not be the most important customer in the system. Then alter your marketing and branding strategy to appeal to the new market.
  • Influencers — The most important customers are often not actually involved in the economic value chain of a product. Instead they are advisers who are key to success. Reviewers are frequently gatekeepers.
  • New decision makers — Within a targeted customer set, redefining the decision makers can be the key to unlocking new profit.
  • New entrants — Sometimes the redefinition opportunity derives from the arrival of a new customer group. These groups emerge for many reasons; deregulation, dramatic changes in costs and prices, technological innovation, or a violent twist in the evolution of customer priorities. The new groups often have needs and priorities that are wholly different from those of your traditional customers.

The shift from old customers to new is an opportunity that should be searched for regularly, across every strategic situation.

What do you do when you're in a Redefinition pattern?

Look beyond your current customer set.
Search the broader system for the most important and the most profitable customers.
Build your business design around them.

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Page content is based upon Profit Patterns, written by Slywotzky, Morrison, Moser, Mundt and Quella, published by Times Business, Random House, copyright © 1999 Mercer Management Consulting, Inc.