by Michael Griffith, NWIRC Manufacturing Technology Engineer
Happy New Year! For many of our regional manufacturers, 2018 sales revenues gave plenty of cause for celebration. The U.S. economy is expected to have grown over 3% during 2018 and many northwest Pennsylvania manufacturers have benefited from national economic growth. Still, the trickle-down effects of the 2017 Tax Cuts and Jobs Act, that has fueled much of 2018 economic expansion, will not last forever. If 2018 was indeed a banner year, the time is now, while sales are good, to look not only how to gain new customers, but also how to shed customers who may be a drain on profitability.
It goes without saying that customers can negatively affect profitability if the combined material, production, and fixed contribution costs of the goods sold to the customer is higher than the selling price of the final product. However, many indirect costs, such as excessive quoting time, engineering time, quality requirements, returns, or other customer service requirements, should also be considered in the total cost of goods sold.
Many people are familiar with Pareto’s 80/20 Principle and its application to sales – roughly 80% of sales revenue comes from 20% of customers, leaving the final 20% of sales revenue from 80% of customers. Less commonly known is that while 20% of customers contribute to 80% of company profits, the next 20-30% of profit is from the middle 40-60% of customers. The remaining 20-40% of customers either generate no profit or draw down profits from overall profitability of the company.
The steps to evaluate customer profitability include:
1. Quantitatively analyze profitability, based upon combined material, production, and fixed contribution costs, of each customer
2. Qualitatively analyze profitability based upon other, sometimes subjective, criteria such as quoting time, engineering time, quality requirements, returns, or other customer service requirements
3. Consider the customer’s potential for increased future growth
4. Consider the customer’s fit in your strategic growth plan or ideal customer profile
While the first step, quantitative analysis, will offer a good list of current customers that are draining profitability, it should not be considered the only criteria for evaluation. A complete customer profitability evaluation, including all four steps, should be performed.
Following these customer profitability evaluation steps can help a manufacturer improve customer service to profitable customers, align its customer base with an ideal customer fit, and grow its business through new customer opportunities. To learn more about resources available to help evaluate the profitability of your customer base, contact your NWIRC Business Advisor.
Michael Griffith has over 20 years’ experience in various manufacturing roles including product development, sales engineering, and sales and marketing management. He’s been with NWIRC for over 6 years helping manufacturers identify and pursue business growth opportunities. Mike has a Bachelors in Chemical Engineering and MBA, both from Penn State.