The Incumbent's Advantage

The Idea in Brief

Many big-company CEOs assume it's hard to grow profits organically, so they seek out new markets or acquisitions to drive growth. And they ignore a goldmine of growth potential that's right under their noses and invisible to rivals: knowledge of their customers.

How to exploit this resource? Macmillan and Selden recommend a disciplined process that sounds obvious but that few companies orchestrate well. Mine your customer data to identify segments based on profitability and needs. Then allocate your company's resources--including marketing and service development dollars--to accomplish one goal: generating more profit from your existing customers.

A cement company did this by finding out which customers would pay what for different formulations of ready-mix concrete (greater strength versus faster pouring) and different services (including design advice). By tailoring its offerings for each segment, it substantially increased profit per ton of concrete.

The Idea in Practice

To grow your company's profits organically:

1. Rank customers by profitability

Identify the 20% of your customers who are most and least profitable. Why? Your top two deciles generate more than 150% of your annual profits. To make up for every top-20% customer who defects, you have to acquire 10-25 new customers of average profitability. So it's critical to retain these customers. The bottom 20% lose an amount equal to your firm's entire profits. Getting them to where you break even would double your company's profits.

2. Identify "candidate" customer segments

Identify statistically significant relationships between your top- and bottom-20% customers' profitability, their behaviors (purchase frequency, service demands), and their demographic characteristics (age, income).

Group similar individuals into segments, using behaviors and characteristics most associated with profitability in your most profitable cohort and with unprofitability in your least profitable group. Identify what benefits each segment wants, and what each is willing to pay for them.

A cement company had developed an additive for ready-mix concrete. The more additive used, the cheaper the concrete and the greater its strength. But more additive also meant less "workability" (slower pouring). The company identified two customer segments: 1) "Strength seekers" used ready-mix for load-bearing applications and needed the higher-strength additive mix. 2) "Workability seekers" poured cement for interior spaces. They wanted the faster-pouring mix, and were willing to pay extra for it.

3. Identify profit-boosting actions

Identify actions (reconfiguring offerings, modifying delivery, altering price) that can prevent defections of your most profitable customers and reduce losses incurred by profit-eating customers. The cement company customized its ready-mix formulas for its two segments, charging a bit more to workability seekers. The move increased its profit from $60/ton to $90/ton.

A distribution company found a large group of unprofitable customers: small contractors who took months to pay because they had to wait for their own customers to pay them first. The company cut a deal with the contractors: a higher price in exchange for delayed payment, and a significant discount for early payment.

4. Allocate resources strategically

Identify additional resources your top and bottom 20% consume--such as marketing, R&D, sales staff, service, and retail personnel. Using your understanding of what the customers need and how much they'll pay, allocate these resources to further boost profitability.

The cement company learned that workability seekers needed (and would pay extra for) marketing consulting to help them translate the mix's benefits into better construction bids. The company transferred marketing resources from strength seekers to workability seekers, which generated $120 profit per ton instead of the original $60.

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Further Reading

Articles

Rediscovering Market Segmentation

Harvard Business Review

February 2006

by Daniel Yankelovich and David Meer

In 1964, Yankelovich introduced the concept of nondemographic segmentation, by which he meant the classification of consumers according to criteria other than age, income, etc. Buying patterns had become far better guides to consumers' future purchases. In addition, properly constructed nondemographic segmentations could help companies determine which products to develop, which distribution channels to sell them in, how much to charge for them, and how to advertise them. But more than 40 years later, nondemographic segmentation has become just as unenlightening as demographic segmentation had been. Today, the technique is used almost exclusively to fulfill the needs of advertising, which it serves mainly by populating commercials with characters with whom viewers can identify. It is true that psychographic types like Joe Six-Pack may capture some truth about real people's lifestyles, attitudes, self-image, and aspirations. But they are no better than demographics at predicting purchase behavior. Thus, they give corporate decision makers very little idea of how to keep customers or capture new ones. Now, Yankelovich and Meer argue the case for a broad view of nondemographic segmentation. They describe the elements of a smart segmentation strategy, explaining how segmentations meant to strengthen brand identity differ from those capable of telling a company which markets it should enter and what goods to make. And they introduce their "gravity of decision spectrum," a tool that focuses on the form of consumer behavior that should be of the greatest interest to marketers--the importance that consumers place on a product or product category.

The Right Way to Manage Unprofitable Customers

Harvard Business Review

April 2008

by Vikas Mittal, Matthew Sarkees, and Feisal Murshed

Problem customers can cost your business lots of money, but quickly ejecting them may not be the best way to relieve the burden. Mittal, Sarkees, and Murshed explore the ins and outs of customer divestment. Using real-world examples, the authors show how deciding to end a relationship with a customer segment or individual can increase profitability, improve employee morale, address capacity constraints, and bolster a business strategy. However, divestment also comes with potential downsides for various constituencies, including employees and remaining customers, both of whom may wonder whether they're next. In addition, ethical and legal consequences--and the risk of bad publicity--always loom. Before you rush to action, say the authors, walk through their five-part customer divestment framework. First, reassess the context of present customer relationships, looking beyond simple profitability. You may find that the most productive option is to educate customers rather than drop them. In some cases, if you renegotiate the value proposition with them, both of you will win. In other instances, you'll want to migrate customers to other subsidiaries or providers, as long as the move is undertaken--and perceived to be conducted--in good faith. If it becomes necessary to terminate a customer relationship, use a direct, interpersonal approach. No business can afford to squander its customer base, so divestment should not be boiled down to determining merely who is profitable and who is not--the strategic consequences are too weighty. In the end, the decision about whether to divest might prove to be the toughest customer of all.

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