The Pareto Principle, commonly called the 80/20 rule, postulates that in business, 80 percent of your profits come from 20 percent of your customers.
And the flip side, that 80 percent of your problems and hassles come from 20 percent of your customers. This principle obviously begets the question of how to identify your “problem 20 percent” and how to best eliminate them from your clientele.
In this article, we’ll discuss three steps you should take to identify problem clients, and the practical actionable steps you can take to turn them away.
Analyze all Client Associated Costs
Businesses considering whether a particular client is profitable cannot simply look at the hours directly devoted to the client, but rather must look holistically at the suite of services that a client demands. This will provide a more robust picture of who is a profitable client, and which clients a business should consider dropping.
Related Article: 6 Signs A Customer Is Not Worth It
Real World Example:
Northwest Airlines, which has since been acquired by Delta, made the news by kicking a customer out of their loyalty program because of his excessive complaints. Looked at in isolation, the customer was actually profitable for the airline insofar as he was a frequent customer.
After factoring in that the customer called customer service 24 times in 8 months and received free frequent flyer miles along with travel vouchers based on small problems he perceived with his service. In this sense, he was, very unprofitable.
By removing him from the program not only did Northwest Airlines save money on this customer, but they also signaled to similarly minded customers that their abusive behavior wouldn’t be tolerated.
Revenue Does Not Equal Profits
Businesses often confuse their large clients, with their profitable ones. Ultimately you want clients to be both large and profitable, but if they are merely the former, it’s time to consider dumping them.
Businesses often look at their revenues and expenses as two separate sides and fail to connect the two on a per client basis.
Sometimes even when they do know that a customer’s lifetime value is at or nearly $0, their instinct is to keep the client because he generates revenue which justifies an expanded payroll, instead of facing the hard decision that personnel cutbacks would serve the business better.
Real World Example:
Houston-based accounting and bookkeeping firm, AC Partners Inc. provides mid-sized businesses with accounting and bookkeeping services.
Historically, the firm has charged its clientele based on a flat monthly fee and didn’t track hours spent serving those clients. The company enacted a 60-day test in which all staff kept detailed breakdowns of which client they were working on.
There they discovered that their largest client, representing 25 percent of the firm’s gross revenue, was not actually profitable once accounting for payroll hours worked. The business, unable to successfully renegotiate pricing with the merchant faced a difficult choice because cutting 25 percent of the company’s revenue likely meant losing an employee.
Ultimately, however, AC Partners decided that simply maintaining non-profitable customers for the purpose of justifying additional staff was not a wise decision, so they dropped the client, and the staff member, who they promised to re-add once they found additional clients sufficient to justify the staffing levels.
Eliminate Scope Creep:
New businesses want to be everything to everyone. Eager to grow their business they will take on new clients who are slightly outside their existing expertise.
As they add new non-core clientele, however, their expertise is less, and their existing processes don’t serve clientele as well. This is known as business scope creep. Consequently, the business ends up spending an inordinate amount of time serving non-target clientele because everything must be done manually.
Real World Example:
General dentist, Thousand Oaks Dental, is a growing general and cosmetic dentistry practice. In an attempt to grow quickly, however, they accepted a wide range of clientele, some of whom were requesting non-core services, braces.
Both because some of their best existing clients were requesting the service, and because orthodontics can be a high margin area of dentistry, the office decided to offer it.
They found that to service the clients, they had to contract with an orthodontist, and because they only had a few patients in braces they were wildly overcompensating the orthodontist.
Additionally, they needed to create all new contracts and paperwork. At the end of the day, by allowing the scope of the services they offered to creep outside of their expertise, these clients became unprofitable.
As a consequence, they stopped offering these services and established strong mutually beneficial referral relationships with an area orthodontist who in turn reciprocated by sending them business that fit their core competencies.
The Pareto Principle has consistently manifested itself across every major business industry. But rather than simply accepting the fact that 20 percent of your business will be not only unprofitable but command 80 percent of the work, you can make headway in this area by actively attempting to turn away some customers.
By taking the steps detailed in this article; tracking profitability as opposed to merely revenue, comprehensively track all associated client costs before analyzing profitability, and reducing scope creep, you can improve your company’s profitability, free your team up to accept additional clients, and focus on your core competencies.