The Right Way to Manage Unprofitable Customers

The Idea in Brief

Some of your customers aren't paying their bills. Others are so high-maintenance that the cost of serving them is eroding your profits. What to do? For many companies, the answer is simple: Show them the door.

Divesting difficult customers has its advantages, but consider the collateral damage: The profitable customers you're keeping may wonder if they're next in line and defect to friendlier providers. And you may do your competitors an unintended favor by sending new business their way.

To avoid these dangers, don't dump customers the instant they become difficult, advise Mittal, Sarkees, and Murshed. Instead, use the authors' five-step process to try to restore customers' profitability. For example, customers who constantly complain may simply need information on how to use your offerings correctly. Use divestment only as a last resort. And do it respectfully, by notifying customers in person.

Apply this process, and you restore more customers to profitability while mitigating the damage of any unavoidable divestments.

The Idea in Practice

The authors recommend this five-step process for managing problem customers:

1. Reassess the Relationship

Determine why the customer has become a "problem." Consider your company's overall relationship with the customer, not just profitability. For instance:

Is a customer who's unwilling to spend (and therefore "unprofitable") simply unaware of the range of services you offer?
Have the customer's needs changed?
Has your company's strategic focus changed, causing you to ignore (and offend) the customer?

2. Educate Customers

Provide information or training to help "problem" customers better understand and use your offerings. They'll have fewer questions--and less need to constantly use your firm's expensive resources.

Fidelity Investments identified low-margin customers who were frequently phoning service reps. Instead of divesting them, Fidelity taught them to use its other (lower-cost) troubleshooting options, such as automated phone lines and the company Web site.

3. Renegotiate Your Value Proposition

If education doesn't improve things, consider pricing and service strategies that restore the balance between the costs of serving the customer and the benefits generated.

A supplier of commercial dyes for heavy machinery started charging extra for on-site service to some unprofitable clients as part of a renegotiated price structure. What could have been an obvious divestment situation became a win-win scenario for the company and its customers.

4. Migrate Customers

For still-unprofitable customers, consider moving them to a different distribution channel, a partner company better positioned to satisfy their needs, or a new form of payment.

Satellite TV service provider EchoStar Communications created a prepaid service option for customers with bad credit history, thus migrating them to a different form of payment.

5. Divest as a Last Resort

If there's still no hope of continuing a relationship with a problem customer in ways that offer enough value for both sides--even after going through steps 1 through 4--it's time to end the relationship. But do so in ways that mitigate any negative fallout for your company. For instance:

With B2B clients, communicate your decision to divest months before a contract-renewal date comes up. Explain your reasoning in person, and help clients recognize that termination may be mutually beneficial.

With B2C customers, provide advance notice in person or by a human voice rather than by an after-the-fact email message or letter. Also, focus your explanation on external factors (such as mounting competitive pressure to change your strategy) rather than simply a desire to increase profits.

When you're trying to identify unprofitable customers, don't look only at the obvious suspects--those problem customers described by Mittal, Sarkees, and Murshed. Also analyze your "loyal" customers. They may not be as profitable as you think. For example, loyal customers who know their value to you may exploit that knowledge to get premium service and discounts. When the cost of serving them rises and the prices you charge them decrease, they become unprofitable. For customers who are very loyal but unprofitable, determine whether they have more money to spend. If so, offer them products related to those they've already purchased.

Bottom-Feeding for Blockbuster Businesses

Harvard Business Review

March 2003

by David Rosenblum, Doug Tomlinson, and Larry Scott

Before you show the door to supposedly problematic customers, consider the "bottom feeder" strategy described in this article. Bottom feeders assess the needs of customers that other companies are shunning, and then develop a business model to turn a profit by fulfilling those needs. Consider Paychex, a payroll-processing company that used this strategy to good effect. Paychex built a nearly billion-dollar business by serving small companies. Established players had ignored these customers on the assumption that small companies couldn't afford the service. Paychex now serves 390,000 U.S. customers, each employing an average of around 14 people.

The Flaw in Customer Lifetime Value

Harvard Business Review

December 2007

by Detlef Schoder

Don't fear acquiring customers who could turn out to be unprofitable. Just know exactly when to divest them. How? Factor options analysis into your calculations of customers' net present value (and thus customer lifetime value). For example, suppose a customer costs $100 to acquire and $100 to retain for five subsequent periods--totaling $500 to keep him. If you expect him to purchase $150 of goods in the first period, $100 the next, $50 the next, and $0 in the final two periods, he'd look unprofitable (generating just $300 of revenue at a marketing cost of $500). But drop him after the second period, and he looks profitable: Over the five periods, marketing cost is only $200 ($500 minus $300 you've saved by dropping him), but his revenues are $250.