As we move into volatile times (again), business leaders more than ever need to maniacally focus on the few customers that matter most to them — and spend much less time on the rest. The customer may always be right, but not every customer is right for you.Some years ago, when our venture firm was starting one of its first retail ventures, I met with a highly successful CEO in the retail services industry to better understand how he did so well across all of his stores (he had some mind-blowing numbers). It was abundantly clear when you walked into any of his stores that his customers were genuinely delighted. I asked him for his secret. His response surprised me and has therefore stuck with me: “When we open a new location we quickly grow to a database of 8,000 customer names — and then work hard to get it down to 1,500 names.”
At first I was taken aback, as it seems counter-intuitive to shrink rather than build your customer base. Upon a little reflection, however, it made absolute sense: ultimately, business is not about growing revenue, but about growing profitable revenue with the right target customer. To get that right customer, you sometimes need to start by casting a wider net, figuring out which customers are the most attractive, and then temporarily shrinking the business before you grow it again. With each iteration, you get smarter and more targeted towards the ideal customer profile.
By focusing on customers with the highest potential in terms of repeat purchases and larger average transactions, one is able to create a more successful business because marketing and customer service efforts (and costs) can be allocated where they matter most. But for many CEOs and founders, the mandate for growth creates a bias for quantity of revenue over quality of revenue. At our venture firm, when we evaluate a business model we think very differently about a dollar of revenue with a high probability of recurrence (i.e. a customer who will buy again, making it high quality revenue) versus dollars of revenue that need to be constantly be replaced with new customers. We believe the threshold for a high-quality-of-revenue business is a revenue recurrence rate of over 85%, meaning losing no more than 15% of a customer base each year. Such businesses have higher predictability in their business model and greater leverage in their sales, marketing, and customer service. A higher quality of revenue means a better long-term business.
If you look hard at who is buying your wares, you can quickly get a sense of where the money is coming from and where your money is being spent. Some businesses exhibit the classic 80/20 rule, with their top 20 per cent of customers making up 80 per cent of the revenue. We have also seen a good number of firms with even more skewed revenue distributions that are closer to 90/10. Yet organizational efforts and resources are often poorly mapped to, or unaligned with, that revenue distribution pattern. In fact, it is often the opposite. That is, the bottom customer quartiles take disproportionately from a company’s sales, marketing, and customer service resources. Some of the most challenging customers are those who in the “low-middle” bucket, buying relatively little, but needing very high touch and maintenance.
Why do so many of us fall into the trap of spreading our efforts evenly across our customer base, or even skewing them towards the lowest-potential customers? It is tempting to embrace every customer equally — and we naturally want to understand why the lower customer deciles are not behaving like the higher deciles. We want to believe that we can nurture and develop all customers to reach high potential levels over time. However, in the companies in which we have been involved, the data do not support that thesis. It is always tougher to change customer behaviour than to find new customers similar to your existing top-buyer profiles.
The top priority for a business that wants high quality of revenues starts with understanding everything possible about the top customers. Drill deep to understand their demographics, psychographic, and purchase behaviour preferences of your “super loyalists.” Where do they come from? What is their attitudinal profile and what bundles of goods do they like best and at what price? Getting an intimate clustering of your top customer base is the foundation for a high-quality-of-revenue business.
By directing more customer acquisition and loyalty costs towards that top cohort, you will be implicitly de-focusing or “firing in advance” the less valuable customer segments. Yes, the term “fire” is a little melodramatic, but it is a clear reminder that limited resources need to be carefully allocated — and that just because you sell something to someone it does not necessarily mean it is a good thing.
Firing your customer does not mean to literally bar the door, but to set conditions whereby lower- priority customers self-select out and higher-potential ones self-select in. For example, for many businesses, first purchase order size is a good leading indicator of future purchases. If you knew that $50 was the average of your top loyalists and $30 was the average of lower tiers, you could simply raise minimum price on an opening order, or only offer free shipping on orders of $50 or above. As another example, for current customers who spend little but cost dearly in terms of customer support or other costs, consider a new pricing structure where higher support services are only free for accounts of a certain size. In effect, you can offer customers the choice to become profitable cohorts or to leave.
Your top-cohort customers are super fans who have voted with their wallets. They are the ones who will recommend you more often than other customers and would miss you most if you no longer existed. Find more people like them, and spend less time trying to turn others into people like them. Thank your best customers to death for their great patronage and worry less about — or simple “fire” — the others.
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