Editor’s Note: Mark Price is one of DMReview.com’s regular online columnists, and we were proud to publish his December column in the December 8, 2000 issue of DM Direct.

I was lecturing to an MBA class several weeks ago, when a new implication of customer-centric marketing arose. Yes, this column is dedicated to the unexpected issues that develop in technology- driven customer marketing. In my experience, I thought I had seen it all, but the capable MBA students proved me wrong.

The question raised was this: As companies seek to better understand the profitability of their customers – what if they succeed? What happens then?

The answer is not as simple as it appears. Most direct marketing experts claim that the goals of customer segmentation are to:

  1. Understand best customers.
  2. Increase depth of relationship within that segment.
  3. Discover customers who resemble best customers, but have not performed at that level,
  4. Develop prospecting mechanisms to encourage prospects that are most likely to become best customers,

In these ways, companies can increase the overall retention and profitability of their customer base, increasing revenues in a sustainable way.
This sounds good. However, the question that emerged in the MBA class focused on the rest of the customer base – what do you do with them? Particularly in industries where customer profitability is highly stratified, the question of what to do with the rest of the customer base will likely become critical to the success of the organization.

For example, a financial services organization identified that 50 percent of its profits came from the top 10 percent of customers. Sounds consistent with typical segmentation, right? But, further analysis revealed that the next 10 percent of customers represented the next 50 percent of profits. Eighty percent of its customers were unprofitable!

What’s a company to do? Eighty percent of their customer base was either of neutral value or fell into the "value-detractors" category, whose cost of service far exceeded their revenue much less the potential for revenue in the future.

A purist might say, "Just jettison all that dead weight and the company should dramatically increase its profitability." Think of the stock value, bonuses, raises, etc. a manager might receive after tripling profit per customer over a short period of time. Just inform those unprofitable customers that they will need to find a new provider – in effect, fire your customers and watch the business soar into profitability. You could also make those customers profitable through fees and up-charges for as long as they stay with you. If they leave, so much the better.

While that may appear to be the easy answer, I believe that such a plan may be highly inadvisable, if not fatal, to the organization for several reasons.

Inaccuracy of Customer Analysis Technology

Remember that predictive modeling provides likelihoods, not certainties, about potential customer performance in the future. Just because a customer does not make a profit for the company today does not mean they will not in the future or will not refer profitable customers. The lack of complete customer knowledge (which is always the case!) means that customers may suddenly shift their behavior in ways that technology cannot predict since the key variables may not be available for analysis at all.

One example of a sudden behavior shift is a financial services customer that inherited a substantial sum of money. All of a sudden, out of the blue, that customer needs significant estate planning, investments/tax assistance, etc. – all of which would move the customer from the lowest to the highest customer segments in a matter of moments. How do you forecast such a change unless you track information such as the net worth of a customer’s relatives?

Sudden and dramatic changes in telephone usage patterns also illustrate this point. While the children are home, long-distance phone usage may be low and the customer disregarded. However, when the family structure suddenly includes an out-of- state college student, that customer’s phone bills may dramatically increase – and stay high – during the four-year college career of each child. As you can see, factors that are not tracked in a customer database can result in significant and lasting changes to a customer’s profitability.

Economies of Scale

Retaining customers who are not profitable may relate to the profitability of best customers in unanticipated ways. Few manufacturing businesses could sustain profitability if the number of customers or orders fell by 50 percent or more. In addition, efficiencies among suppliers must also be considered, lest the company find themselves the victim of their own devices in the face of skyrocketing costs.

Economies of scale provide benefits beyond financial ones. A volume of customers also permits the company to rapidly proceed down the learning curve in customer service and support, as well as in manufacturing. The larger the base of learning about customer issues with a product/service, the easier it is for the company to identify solutions and develop systems to proactively address those issues. Proactive, information-savvy companies often incorporate customer education, self-help systems or superior training of customer support staff to address or bypass customer problems. Such activities are critical to justifying a premium price for the company’s products and maintaining or increasing customer retention among best customers. In these ways, customers who are not profitable may be contributing to the overall success of the business.

How you treat unprofitable customers may also have an effect on the retention of your best customers. Remember, best customers have developed a relationship with your company that is distinct from the relationships they have with many generic suppliers. That relationship is built on trust and a sense that the company is not the same as all the others. After all, if your company were the same as the others, then the best customers would differentiate primarily based on price, leading to a generic business and declining margins. The moment that best customers discover that you treat other customers in a less than adequate manner, you begin to break down the fragile trust bond that makes those customer unique in your portfolio. They surmise, "What if I slow down my purchasing, would I be treated the same as them?" Maybe another company would reward less profitable customers with a higher overall level of satisfaction. When a best customer begins to think that way, it is just a matter of time before they go to your competitor. The goal, after all, is to prove that your company is different, not the same, from others in the category, right?

In this way, you can see that active discouragement of unprofitable customers may impact both top-line revenue and bottom-line profit in unexpected ways.

Federal Regulations

What if you discover that all your best customers live in the suburbs, and that unprofitable customers predominate in the inner cities? What do you do then? Active discouragement (or even passive discouragement) of inner city customers may be perceived as violating laws that prohibit discrimination on the basis on race or income. The targeting of best customer acquisition by demographic segment can be controversial enough – the "shedding" of unprofitable customers may be much more so. Public relations aside, the more important issues are ethical ones that can be costly, so retaining less profitable customers may be the preferred course.

The ethical issues around best and worst customer management are significant and closely linked to overall company mission and values. The issues include:

  1. Does your company want to be known for dumping customers of all kinds, let alone inner city or lower income customers, just to increase profits alone?
  2. Do customers have a right to stay with your company and cause you to lose money? If not, what is the appropriate burden that unprofitable customers should bear to assist your company in improving performance?

The answers will require consideration of and dialogue with all your stakeholders: management, shareholders, communities, government and more. The answers will be complex. However, finding the right answers (or at least not the wrong ones) will be essential to the continued success of your company which can translate to retention of employees, best customers and the trust of your company’s community.
Concluding this article with an ethics discussion does not represent the order of planning, of course. The issues raised here should be addressed at the start of a customer segmentation and profitability assessment rather than at the end. By leading with well thought out plans and guidelines, the company can set out a framework to permit the company to have the best chance for long-term success.

The insights that emerged in my MBA lecture are, I believe, central to the success of an organization that is serious about incorporating customer management into their overall business model. The key is to consider the long-term impact of the technology for marketing and customer management before the issues arise. By planning ahead, you will address the potential pitfalls and agree on principals and policies that will guide managers as they make the decisions that affect profitability and business growth.

In this way, you can continue to make best customers the foundation of a growing, thriving enterprise and not sink in a quicksand of your own making by mismanaging other segments that may be more critical than they appear.

Register or login for access to this item and much more

All Information Management content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access