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Buyer Bargaining Power (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Threat of New Entrants
Intensity of Rivalry
Threat of Substitutes
Supplier Power
Supplier Power Analysis

Buyer Power Definition

Porter’s Five Forces of buyer bargaining power refers to the pressure consumers can exert on businesses to get them to provide higher quality products, better customer service, and lower prices. When analyzing the bargaining power of buyers, conduct the industry analysis from the perspective of the seller. According to Porter’s 5 forces industry analysis framework, buyer power is one of the forces that shape the competitive structure of an industry.

(See the other Porter’s 5 forces of competition.)

The idea is that the bargaining power of buyers in an industry affects the competitive environment for the seller and influences the seller’s ability to achieve profitability. Strong buyers can pressure sellers to lower prices, improve product quality, and offer more and better services. All of these things represent costs to the seller. A strong buyer can make an industry more competitive and decrease profit potential for the seller. On the other hand, a weak buyer, one who is at the mercy of the seller in terms of quality and price, makes an industry less competitive and increases profit potential for the seller. The concept of buyer power Porter created has had a lasting effect in market theory.

Conducting an industry analysis can be overwhelming and confusing. Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market. 

Buyer Power – Determining Factors

Several factors determine Porter’s Five Forces buyer bargaining power. If buyers are more concentrated than sellers – if there are few buyers and many sellers – then buyer power is high. Whereas, if switching costs – the cost of switching from one seller’s product to another seller’s product – are low, the bargain power of buyers is high. If buyers can easily backward integrate – or begin to produce the seller’s product themselves – the bargain power of customers is high. If the consumer is price sensitive and well-educated about the product, then buyer power is high. Then if the customer purchases large volumes of standardized products from the seller, buyer bargaining power is high. If substitute products are available on the market, buyer power is high.

And of course, if the opposite is true for any of these factors, buyer bargaining power is low. For example, low buyer concentration, high switching costs, no threat of backward integration, less price sensitivity, uneducated consumers, consumers that purchase specialized products, and the absence of substitute products all indicate that buyer power is low.

Buyer Power – Analysis

When analyzing a given industry, all of the aforementioned factors regarding Porter’s 5 Forces buyers power may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high buyer bargaining power and some may indicate low buyer bargaining power. The results will not always be straightforward. Therefore, it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

Buyer Power is High/Strong if:

• Buyers are more concentrated than sellers

• Buyer switching costs are low

• Threat of backward integration is high

• Buyer is price sensitive

• Buyer is well-educated regarding the product

• Undifferentiated product

• Buyer purchases product in high volume

Substitutes are available

• Buyer purchases comprise large portion of seller sales

Buyer Power is Low/Weak if:

• Buyers are less concentrated than sellers

• Buyer switching costs are high

• Threat of backward integration is low

• Buyer is not price sensitive

• Buyer is uneducated regarding the product

• Highly differentiated product

• Buyer purchases product in low volume

• Substitutes are unavailable

• Buyer purchases comprise small portion of seller sales

Buyer Bargaining Power Interpretation

When conducting Porter’s 5 forces buyer power industry analysis, low buyer bargaining power makes an industry more attractive and increases profit potential for the seller, while high buyer bargaining power makes an industry less attractive and decreases profit potential for the seller. Buyer power is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework. Many respect the buyer power Porter’s five forces.

Start preparing your external analysis so you can react in realtime when the buyer’s have bargaining power over your company. Don’t loose out because of an external force. Download the free External Analysis whitepaper by clicking here or the image below.

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Maximizing Your Bottom Line In 3 Simple Steps

Sales are great, but wouldn’t they be better if you were actually able to reap the rewards? Many CEOs that were not trained with an accounting/finance background struggle to understand profitability. They think that if sales are great, then the business is great. But when sales increase, inventory and overhead increases. Productivity also decreases – due to exhaustion or overwork. Collections lapse because there isn’t a “pressure” to collect. And unfortunately, that is when companies suffer the most. Sales start to decline, but they don’t change their habits. In this Wiki, you will learn how everything below sales on your income statement is critical to your company’s success and how you should be maximizing your bottom line – net income – at any stage of your company’s life cycle. Let’s look at how maximizing your bottom line in 3 simple steps can happen.

What is the Bottom Line?

First, what is the bottom line we are referring to? It is the net income on your income statement or P&L statement. This is what you have left after all the costs of goods sold, administrative expenses, and overhead have been subtracted from revenue. We look at this number carefully because that is how much you are able to put into retained earnings or reinvest back into your company. In addition, the amount can be used to issue dividends to their shareholders. Maximizing your bottom line should be an integral part of your company’s processes.

Profitability starts at the top of the income statement. If your prices are not set to create profitable environment, then you will be not able to maximize the bottom line. Learn how to price for profit using our Pricing for Profit Inspection Guide.

Maximizing Your Bottom Line In 4 Simple Steps

There a are several ways to maximize your bottom line – some more extensive and time consuming than other. But there are 3 areas to focus on to maximize your bottom line – including productivity, overhead, and collections.

1. Productivity is Key

It’s been a common theme among business blogs and news sources (Entrepreneur, Forbes, WSJ, etc.) to improve productivity. Why? Because productivity is key in maximizing your bottom line. But what really happens when you improve productivity? You have more supply, decrease the cost to produce 1 unit, and increase sales. It speeds up your operations so that you can fulfill more orders for quickly.

2. Manage Overhead

Great revenues have very little meaning if your overhead costs are not properly managed. Look deeper into your overhead expenses and find out if there are any costs you can reduce or completely remove. The problem is often more complex than large expense accounts on the P&L. You must interact with various departments to think critically and solve problems. Ensure that every single overhead cost is necessary to provide the desired service levels. Maximum controllability over costs leads to higher profits for the company to reap.

3. Collect Quicker

Collections are an important part of business. If a company sells $10,000 worth of product but only collects $3,000, then their cash is tied up in inventory, etc. As a result, they experience a cash crunch. We have worked with clients who were in the same situation and they neglected to ever collect the outstanding balance. Their bottom line suffered, but they didn’t think to look at their collections process. There are two metrics that you can look at to monitor collections and use to collect quicker.

The first metric is DSO. Do you know your Days Sales Outstanding (DSO)? This is a great measurement to know where you are currently and how by making slight adjustments, you can increase profitability. Use the following formula to calculate DSO.

 DSO = (Accounts Receivable / Total Credit Sales) * 365

The second metric to look at is Collections Effectiveness Index (CEI). This is a slightly more accurate representation of the time it takes to collect receivables than DSO. Because CEI can be calculated more frequently than DSO, it can be a key performance indicator (KPI) that you track in your company. If the CEI percentage decreases one month, then leadership are alerted that something is going on. The goal here is to be at 100%.

CEI = [(Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) ÷ (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables)] * 100

Another method to collect quicker is to tie receivables to the sales person’s commission. This will not only encourage your sales team to be part of the collections process, but it will help keep your company cash positive.

Effective Strategies for Improving Profitability

While we’ve been focused on maximizing your bottom line as your current financials stand, we also wanted to share some effective strategies for improving profitability.

Price for Profit

Are your prices leading to a satisfying net income?  If not, then these are some questions you can inquire:

  • Are additional costs being reflected on the price?
  • Are you using Margin vs Markup interchangeably?
  • Is your overhead being covered?

The solution might be simple: Adjust your price!

Learn how to price for profit using our Pricing for Profit Inspection Guide. This whitepaper will help you identify if you have a pricing problems and how to fix it.

Create Standard Operating Procedures (SOP)

Also, create Standard Operating Procedures (SOP). SOPs are step by step instructions written by a company to assist employees in completing routine procedures. They are necessary in a company to ensure operations run smoothly. The better your company’s SOPs are, the more efficient it will run. Create operating procedures that are simple, easy to read, and most importantly make them lead to a purpose.

Focus on Profitable Customers

Identifying profitable customers is instrumental to a company’s success. Once you completely identify your most profitable group of customers, focus your attention on them. Use your marketing funds primarily on you most profitable customers. A customer outside of that target market is still a viable customer, but they just shouldn’t receive as much marketing attention since they are not their primary and most profitable customer segment.

When maximizing your bottom line, start with your prices and pricing process. Access the free Pricing for Profit Inspection Guide to learn how to price profitably.

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Identifying Profitable Customers

identifying profitable customersIdentifying profitable customers is essential to a business’s success. Often I hear from financial leaders… “I don’t need to worry about the customers; that’s the marketing and sales team’s job.” WRONG. Everyone in your company should be concerned with your customers because without them, there is no business.

If it turns out that most of your customers are unprofitable, you have a problem. The two most effective ways to address unprofitable customers is by either cutting costs or raising prices.

There’s an easy way to do both, but you can only find the detailed plan in our Pricing for Profit Inspection Guide. Download this guide for free by clicking here.

Why Identify Your Most Profitable Customers?

So why should you focus on identifying profitable customers? If you are in charge of managing profits and cash flow, you must know your customers. Truth is, not all customers are created equal.

identifying profitable customersEver heard of the 80/20 rule? Typically, it is used in reference to productivity. But the reason why you need to identify your most profitable customers is because often, 20% of your customer base makes up 80% of your profit.

There are several things that you need to ask yourself when identifying profitable customers…

  • What is your customer segmentation by channel?
  • Who are your least profitable customers?
  • What products are being bought by most profitable customers?
  • What product most often purchased?
  • Which are your most profitable products?
  • What services are utilized by profitable customers?
  • What are the costs (tangible and intangible) associated with profitable customers? Unprofitable customers?

What do you do with the unprofitable customers?

Some indicators that a particular customer is likely unprofitable are abusive behavior to your sales and support team, general aggravation, seeking undeserved credits, requiring more time than the typical customer, and not completing tasks to move along project. Although there are more indicators, this list gives you an idea of what to look for to identify your unprofitable customers.

How to Identify Profitable Customers

An example… in working with one of our clients, we discovered that people ages 45-65 were their most profitable customers based upon the length of time they subscribed to their product. On average, those in that age category subscribed for 14 months. Whereas, those under the age of 45 only subscribed for 3 months. When we worked with our client to calculate cost to acquire each customer and the lifetime value, we were able to make an educated decision to invest in those ages 45-65.

Now that we have identified our client’s most profitable customers, our client puts a large portion of marketing funds to the ages 45-65. A customer outside of that target market is still a viable customer, they just don’t get as much marketing attention the since they are not their primary and most profitable customer segment.

Service Companies

For example, in the service side of our company, we monitor the costs associated with that particular client. If we find that we are spending more than we are making, there are two things that we need to do: figure out why the costs are so high and calculate whether we need to charge more. By knowing our unit economics, we are able to quickly judge whether a client is profitable or not.

If your costs are too high for what you are charging, it’s time to price for profit. Download our free Pricing for Profit Inspection Guide to easily discover if your company has a pricing problem and fix it!

Product Companies

Typically, a product is sold at one price point. Because of that, some companies may fail to look at the profitability of their customers. As we have worked in multiple industries, we have found that there are several areas to look at to improve profitability, including the following:

  • Customer Base
  • # of Products Purchased
  • Demographics
  • Lifetime Value of Customers
  • Channels

By using these areas, our clients have been able to shift their focus on their profitable customer base (and lookalike audiences) and consequently increase the number of products purchased per customer, decrease refunds, and increase the lifetime value of a customer. Sounds a little bit like marketing, right? But as a financial leader, you must operate in sales, marketing and operations to effectively lead the company forward financially.

identifying profitable customersNurture Profitable Customers

If you’re identifying profitable customers, you might see how the company can nurture its most profitable customers. What does your support department do differently with the favorite customers versus those that ruin their day? Partner with your sales and support teams to address how to better nurture them.

How to Deal With Unprofitable Customers

Because there is a limited amount of time in the day, deal with your unprofitable customers and set up procedures to address them to ensure economic success.

Don’t Focus On Them

If you keep giving five star service to those that abuse it and continue to demand or expect excellence, you are going to experience increased costs (and frustration from your service team) associated with servicing that customer. Remove the focus from them.

How would you go about doing this? Encourage your front line employees to provide limited attention. Sure, some customers will leave. But in all reality, you don’t want to keep those customers AND it’s easier than you having to fire them.

Set Boundaries

In the case that you have a client who abuses the kindness of your front line employees, you need to call a meeting to address those behaviors AND set boundaries between the customer and the company. If you’ve been in business long enough, think of that client who did all of the following things:

  • Demanded too much time
  • Didn’t do what they were told
  • Expected more than they were willing to pay for

How is this a financial leader’s role? Make employees feel like it’s okay to do so, and they won’t be punished for impacting the financial success of a company. Show your team the economics, and give them the power to push back against those unprofitable customers.

Increase the Price for a Service

Price is often one of the largest deciding factors for a prospective customer when deciding which firm they want to work with. It would only make sense that to make up for the hassle factor of unprofitable customers, you need to increase the price you are charging for your service. Chances are, if you find them difficult to deal with, your competitors do too and have adjusted their prices accordingly.  To learn how to price for profit, download our Pricing for Profit Inspection Guide.

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How do you tell an entrepreneur that their business sucks?

business sucksYour business sucks…
How does that make you feel? Probably upset, maybe a little defensive. But what if it’s the truth? Many entrepreneurs generate new ideas as if it were a bodily function. As you have likely seen, not all ideas result in a multimillion dollar venture. Some of those ideas will fail to even bring a penny in!
In the business world, no one will outright tell you idea or business sucks because of business etiquette. However, that doesn’t mean that people don’t think it. After working with CFOs and Controllers for the past 25 years, I have learned that the majority of financial leaders will not tell their entrepreneur (or boss) that their business sucks, even when it does. Unfortunately, the truth needs to be told.
Before we go into how to give them the bad news, it’s critical to identify if there really is bad news to give.
As the financial leader of your company, it’s your duty to vet new ideas. This is part of the responsibility of being a wingman to your CEO. If you’re interested in learning how you can elevate your status, download the free How to be a Wingman guide by clicking here.  

How To Identify If Your Business Sucks

Have you ever seen an ugly baby? Most of us have, yet no one thinks that their baby is ugly. In much the same way, entrepreneurs think that all of their ideas are home runs and most people won’t tell them that their idea baby is ugly.

Unfortunately, all entrepreneurs are going to make at least one wrong call. Because you are their wingman, you should be guiding your entrepreneur to take financially sound risks. But before you tell your entrepreneur their business sucks, there are a couple things to look at when identifying whether an idea or business is worth investing in.

business sucks

Is it profitable?

If the idea or business is not profitable, you should not pursue it. This is the easiest way for a financial leader to identify that the business is not going to be successful. As the financial leader, you should be able to steer your executive team to a more successful and profitable road.

Are customers leaving?

Churn. If your customers are leaving quicker than you are bringing new ones in, your business probably sucks. Churn is one of the KPIs that we use to indicate the success of our business. If you are not able to reduce that number in your business, then your business will likely fail. A business cannot survive without its customers, so this is a telltale sign that your business sucks.

If customers are leaving quicker than they are coming in, look at your current strategy and pivot. This may mean that your entire business strategy is not working or just a small sliver of it. The product may not match your audience. As a financial leader, it is important for you to understand both the sales and operational legs of your company. Finance doesn’t have to be simply a cost center. You can only cut so many costs in the business before you need to turn your focus on how to improve the business itself.

No Buy-In From the Team

If you, the entrepreneur, or the person who came up with this new idea or business strategy is left all alone without any support from the team, that’s a problem. An idea cannot successfully come to fruition without buy-in from the team. Why? Because the team’s support and belief that this idea will be a winner is critical to its success.

Have you ever been told to do something that you truly didn’t believe in or want to do? Most likely, you didn’t put your best effort into that task. Other tasks took priority in your book so that you would not have to bring that idea to life. You may have spread your negative attitude towards “it” to other employees, essentially building a coalition against “it”.

I have been there. My clients have been there. You have probably been there (either on the ideation side or the fulfillment side). That is why it is essential to have a strong buy-in from the team when deciding to pursue a new business venture, idea, or strategy.

business sucksThe Numbers Don’t Add Up

Oftentimes when someone isn’t in the day-to-day financials and doesn’t understand how an idea impacts the company, it’s easy to punch a few numbers in the calculator. This habit is what leads to people being calculator rich. Even if the person operating the calculator knows their economics, it’s easy to be blind to the bigger picture when you have a shiny idea sitting on your desk.

But after the dust has settled, it is important to nail the numbers down out to see if it is really viable to pursue. In my business, I consistently have to reevaluate whether the numbers actually add up after I have had a couple hours or days to sit on it.

How To Let the Entrepreneur Down Easy

Naturally, entrepreneurs are bold, risk takers. If you outright tell them that their idea isn’t the best thing since sliced bread, it’s going to hurt their ego (and potentially more). They are all excited about this new idea, and they are great at convincing you and making it incredibly difficult to disagree with them. You want to let the captain of your ship down easy, but how do you do that when the truth is… Their baby is just plain ugly.
HINT: You have to be a trusted advisor to your entrepreneur. (Download the How to be a Wingman guide to start letting your entrepreneur down easily, while still moving forward.)

Your Baby is Ugly

Several years ago, I had a client who wanted to get out of a lengthy banking relationship. Red flag #1. This client had broken several debt covenants and were out of compliance. The bank was telling my client that their baby was ugly. They were put into a work out group, where it was the bank’s decision to either work them back into compliance or kick them out of the bank. Why was my client’s business so ugly? It started with their financials.

Instead of going through the process of fixing the ugliness of the financials, my client wanted to break up a long-standing and generally successful relationship. The owner was hurt and felt defeated. When I started working with the owner, I explained that there was an opportunity to fix the financials, get back into compliance, and grow like crazy. It wasn’t like they had severely strayed off of the pathway to success, but they were riding on the backroads. My job was to let the entrepreneur down easy.

“If it were my company…”

The way to do this is to go back to your pre-marital counseling. One of my team members just recently got married, and we were joking about some of the things she learned in pre-marital counseling were the same things I heard 30+ years ago. To prevent any blaming or hard feelings, it’s important to fight with feelings. No one can argue with your feelings. “I felt _____ when you did ______.”
The same methodology happens in business. Start by saying, “if it were my company, I would do this…” A) No one can argue with how you feel you would do something differently. B) You’re not telling them their business sucks but rather having a conversation. C) There are no hard feelings.
For example, if one of my team members suggests ideas to better my business, I’m going to be more open to those suggestions. However, if she starts telling me that I’ve screwed up and my business sucks, I’m going to get defensive. Create a dialogue, rather than an argument. An idea is just an idea in the beginning. Even if the idea becomes a reality in the end, I, as the entrepreneur of my company, have the final say so.
Guide your CEO or entrepreneur effectively as their wingman. This ability to be the trusted advisor your CEO needs will elevate your status, increase the amount of trust, and steer your company to success. Download our free How to be a Wingman guide today!

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The Butterfly Effect: Planning with External Analysis

planning with external analysisEvery decision you make as a financial leader affects your business. Looking back on 2016 to now, a lot of events happened and changed the course of business. Often, there are events occurring in the world that either directly or indirectly impact your company. As a financial leader, it’s up to you to decide how to change your business, or if you should keep it the same. But you need to start planning with external analysis.

How External Factors Destroy a Business

Worst-case scenario, a company will collapse due to an event that occurs externally. Here are a few examples of why external factors might actually destroy your business:

Your Company Can’t Keep Up

It’s all about infrastructure. How does your company stay in the game? If you think about it, the core of the company requires a strong group of individuals to keep the company together. Without a strong team, the company will crumble. Analyze your internal situation as well as your external situation: be aware of bitterness, fatigue, and boredom within your staff.

Competitors Fix the Problem Before You Do

“When the going gets tough, the tough gets going.” If we really think about this phrase, it’s true.”The going gets tough” means the situations around you are getting increasingly more difficult. “The tough get going” means that the strongest people work through the problem as fast as possible. If your competitors can solve the problem before you can, then your company becomes irrelevant.

Customers Adapt to the Change

Like we discussed in last week’s blog, the number one reason for startups failing is creating a product that customers don’t need. This can also be applied to businesses that already exist. If a customer doesn’t need a product, they won’t buy it. For example, the hard drive market shrank rapidly after the creation of the cloud. The cloud solved the issue of limited storage. Since then, customers adapted to the change and the hard drive market continues to shrink. Now, it’s up to the hard drive companies to make their change in order to gain new or keep current customers.

Not used to change? Planning with External Analysis helps anticipate obstacles before they affect your business. Download now!

Planning Strategically

As you can see, it takes a lot of adaptation. Over the past year or so, we’ve been getting a lot of traffic from the middle east. Everyone at The Strategic CFO wondered, “Why is this happening?” We caught up on the news and realized that oil prices collapsed.

As a result, the people in the middle east have a renewed interest in all things financial because they wanted to take initiative and start their own companies. To adapt to this change, we shifted our focus and paid more attention to them in our blog and communication.

You, too, can adapt to change. It’s a matter of staying alert, and responding to a pattern. In this case, we took note of our target demographic, and shifted to cater to them.

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Porter’s 5 Forces

Porter’s 5 forces was created by Harvard Business School Professor, Michael Porter. The model exhibits 5 forces of competition within an industry, affected by multiple aspects of the industry and the environment. The 4 aspects that affect competition include the bargaining power of buyers, the bargaining power of suppliers, the threat of new entrants, and the threat of substitute products.

Analysis of Porter’s 5 Forces

If you think about it, all four of those aspects affect the competition equally, and are affected by spontaneous events. Bargaining power of buyers means that the consumers create pressure for a business to change its product and overall model.

Supplier power refers to the amount of influence the supplier has over a business’s decisions. An example of supplier power is oil and gas pricing. Due to the events that happen in the oil reserves, the prices fluctuate.

Threat of new entrants is the threat that new competitors present in any given industry. In a profitable industry, competition will be saturated. One of our interns told us about an ice cream owner the other day, and he said he and his partner were going to open their shop in Los Angeles. Unfortunately, they couldn’t enter the market because of the competition. As a result, he moved to Houston, posing as a threat to the Houston ice cream market. His product is common with a unique twist, but he entered a less-saturated market.

Finally, the threat of substitutes is the threat of a new product replacing an existing industry’s product. Let’s use an airline as an example. If a new airline provided a better price and better experience, consumers would most likely choose that airline.

Dealing with competition is always tough. Download this External Analysis to beat your competition to the punch!

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Planning With External Analysis

SWOT analysis considers Strengths, Weaknesses, Opportunities, and Threats. Opportunities and threats are the focus for external factors. These environmental changes are most likely variable, unpredictable, and out of your control.

Environmental changes are similar to “the butterfly effect” – the concept that small changes have large effects. What happens across the world may have a large impact on your company. Not all change is negative – it is possible that what happens halfway across the world might increase your revenues in some way. In that case, you’ll still have to prepare… even if it’s not for the worst.

“Plug In” as a financial leader

As a financial leader, you have to be plugged in. News isn’t always for entertainment! In a way, it’s an indication of what your next move is. When planning with external analysis, consider more than what is happening today. Consider what might happen 3-6 months in advance, based on what is happening and has been happening lately.


Some say that the flap of a butterfly’s wings control the tides on the other side of the world. This concept, although somewhat overstated, is a great metaphor for environmental changes. What happens in Saudi Arabia may not affect us now, but maybe it might 5-6 months from now. The best part of adapting: always preparing for the worst.

Prepare for the best… and the worst. Download the External Analysis to gear up your business for change.

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What do you do with unprofitable customers?

Have you ever come across that one customer who you would do anything to get rid of? Have you ever questioned what to do with the customer that causes more strife than good?  Whether they’re a drain or merely a pain, these customers cost you money.  So what do you do with unprofitable customers?

Business is a two-way street. Customers should be as beneficial to you as you are to them. Over time, customers who are not as profitable wiggle their way into your business. How do we find out which customers are profitable and which are not?

Evaluating your customers and how they impact your profitability is just one of the many ways to improve cash flow. Download the free 25 Ways to Improve Cash Flow whitepaper to learn 24 other methods.

Defining Your Profitable Customers

Let’s take a look at your numbers. Does your sales volume reflect the number of customers you spend your time with? More specifically, what are your ratios for the number of transactions and average sale per transaction? If your ratio is pretty high, and your margins are low, that’s a warning sign that it’s time to weed the garden.

Customer Profitability & Cash Flow

Profitable customers have a huge impact on a company’s cash flow. Maintaining customer profitability means managing your costs (and thus cash flow) associated with that particular customer.

1-customer-segmentationThe first step is to manage customer segmentation. Allocate fewer or less expensive resources to those customers that are known for taking advantage of you.

The second step is to measure each customer’s margin. This will allow you to compare each customer and see where you should be spending your time.

The third step is to measure the lifetime value of a customer. This is a KPI that we use and find valuable as a metric for conversion rates.

The fourth step is to manage customer impact.  What would your business look like if you sent this customer packing?

The last and most important step is measure customer profitability.

Customer Profitability Analysis

First, you have to segment your total customers based on your servicing characteristics. This looks at the number of transactions and the sales volume. You can then calculate the profitability of a customer by subtracting your estimated relative cost to service from the revenue for the various segments.

Conduct your customer profitability analysis to start eliminating customers that are costing you money, focusing on those customers that are profitable, and increase productivity in your organization.

But putting the math aside, you should probably look back on the patterns and relationships with those customers… Are your customers rude and putting off certain payments? Are they a pain to deal with?  Do they expect special treatment for a bargain price?

Want to know other ways to free up your cash flow? Access the 25 Ways to Improve Cash Flow here!

Firing Your Customers

Once you determine who your unprofitable customers are, you need to fire them. I know what you’re thinking… “How do I fire someone that brings me money?!” But that’s the problem. They are consuming resources you could dedicate to profitable customers, so they are actually costing you money.

Firing those unprofitable customers opens up opportunities for your more profitable customers. You can spend more time, money, and effort on the people worth focusing on.

Last-Minute Lisa

Let’s say a customer calls you on Friday afternoon and needs an order rushed out by the end of the day. This customer also consumes extra resources because you have to pull extra workers to complete the order quickly.  Unless you charge a premium price for rush orders, this customer is less profitable because they consume more resources. Not sure who these customers are?  Talk to your operations people.  They know.

Slow-Mo Joe

Another customer is always slow to pay their invoices.  In order to collect, your A/R clerk has to make multiple calls and re-send invoices because they “lost” them.  Because they consume more resources than customers who pay regularly, they are less profitable than other customers.  In addition, they constrain your cash because they are slow to pay.

Tiny Tim

Tiny Tim is the customer that only orders in small batches.  Your manufacturing process requires set up time for each order, so small batch orders are less profitable than large orders due to the cost of setting up the machinery for the order.  If you don’t have premium pricing for small orders or include set up time for each order, you don’t make as much money on smaller orders as you do for large orders.

Last-minute orders, delayed collections, and small batches can seem insignificant in isolation, but if a customer continually takes advantage of you, those costs can add up quickly.

Benefits of Weeding the Garden

Increase Productivity

If you continually weed your garden, it allows you to take bite-size pieces in cleaning up. This improves productivity immensely. Use the metrics/steps mentioned above to measure customer profitability and act in real time.

Nourish Profitable Customers

Identify profitable customers. Funnel more resources into those customers that are profitable. Just like soil needs nutrients, your good customers need resources. Avoid nourishing unprofitable customers.

Build a Better Garden

Weeds (unprofitable customers) tend to choke out healthy plants. Build a healthy garden by removing those weeds and unhealthy elements that restrict the growth of your company.

For other ways to improve cash flow, download the 25 Ways to Improve Cash Flow whitepaper to start identifying how profitable customers impact your company.


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Fire Your Customers to Improve Cash Flow

Recently, I was having lunch with one of our strategic partners. He was sharing a story with me about a customer they were having problems with.  He talked about how difficult the customer was to service. Consequently, that customer consumed more of the firm’s resources than other customers. But he was charging them the same fees. I responded that sometimes, you just have to fire your customers to improve cash flow.

The Cost of Keeping Difficult Customers

Sadly, the situation is not unique to my friend’s firm.  Many companies keep difficult customers on board in fear that losing the business will damage profitability and cash flow. What is often overlooked are the hidden costs associated with keeping these customers.

How much productivity is lost servicing the customer who calls on Friday at 4:00 with a rush order?

What are the costs associated with chasing down payment from a habitually late-paying customer?

Sometimes, you create difficult customers from your internal company practices.  A few years ago, a client of ours was struggling to understand why, despite increased sales volume, their profitability remained flat.  What we discovered is that they were taking a large number of small orders that required as much manpower to process as a larger order would. The resources consumed by processing all these small orders wasn’t reflected in the sales price. As a result, profitability and cash flow didn’t improve as expected with increased sales volume.

Fire Your Customers to Improve Cash Flow

So what’s a business to do?  Problem customers hurt profitability. In addition, the drain on cash flow caused by servicing these customers can also seriously hinder the company’s ability to grow.  As difficult as it may be, one of the most effective ways to improve profitability and free up cash is to “fire” difficult customers.

fire your customers to improve cash flow

It’s true that some customers may leave if you increase their price or require a deposit. But weeding the company garden of these problems will free up resources to service more desirable customers.  You will not longer see those that stay despite these measures as problem customers. Instead, you will see them as keys to the company’s success.

Often, the business you don’t take can be as important as the business you do take. When you identify those customers who are draining company resources, either fire them or take steps to turn them into desirable customers. As a result, you can free up company resources tremendously.

(Looking for other ways to increase cash flow and profitability? Download our free list “25 Ways to Improve Cash Flow“).

fire your customers to improve cash flow

fire your customers to improve cash flow

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