Customer Stratification 101: Understanding How to Drive Profit
When we spoke to a president of a wine distributorship, he was adamant about the age-old lesson that, at the end of the day, people buy from people. He insisted that understanding your customers is as, if not more, important than getting lost in technicalities and spreadsheets. Arming yourself with knowledge about your business’ customers means you can classify each account based on buying power, profitability, and cost-to-serve. From here, you can take a tactful approach to nurture each customer account. This customer stratification gives you ultimate control in growing your revenue.
Key Uses of Customer Stratification
- Pricing optimization
- Sales team attention
- Marketing communications
- Finding growth opportunities
- Company-wide prioritization
- Inventory management
- Negotiations
- Compensation
How Does Custom Stratification Work?
To start, customer types are generated based on two main factors: customer lifetime value and net profit. Customer lifetime value is assessed by their buying power. Net profit is determined by their profitability and cost-to-serve.
Customer Lifetime Value – Buying Power
Buying power is broken into sales revenue, unique products, and unique orders. Here, we are most interested in factors like what product they purchase and how much revenue they generate for your business. When determining a customer’s buying power, you need to ask yourself which of the three pieces is most important to your business (sales revenue, unique products, or unique orders).
For some applications, total sales revenue will be of utmost importance, and you’ll want to use that as an indicator of buying power and customer lifetime value. In other cases, unique products may hold greater importance to you. The relative importance of each is fluid and should be assessed and reassessed on an ongoing basis.
Pricing optimization tools like White Cup Pricing simplify this process by generating configurations for all of these pieces that can be customized later according to your business needs.
Net Profit – Profitability and Cost-to-Serve
Profitability includes factors such as gross profit percentage, average order size, and margin. Cost-to-serve looks at precisely what it costs your company to do business with a particular customer, like average line items, percent of returned items, and average days to pay.
Consider average order size. What will directly impact your net profit is the average order size that a particular customer makes. Customers with larger orders are generally more profitable because you need to ship fewer orders. Especially at a time like today when gas prices are surging up, the larger the order, the more profitable it’ll be for you.
Your cost-to-serve is where you really get into the understanding of your business—what is costing you the most amount of money. It’s always a good idea to look at your financials and general accounting to find where your struggles are. For example, if cash flow is an issue, average days to pay will be much more important than your average line items or average line dollars. Additionally, if you have a big return problem where you constantly need to process returns, then you will want to place a greater emphasis on that metric when determining customer types.
Putting it All Together
While the pieces within buying power, profitability, and cost-to-serve all have relative importance depending on your business needs, their overall importance will vary depending on your business. No matter how you break down sales revenue, unique products, and unique orders within buying power, you could find that buying power pales in comparison to the importance of profitability and cost-to-serve when it comes down to your bottom line.
Customer Types
Looking at the graphic, you’ll see that customers in the top right will be the most valuable to your organization. Oppositely, customers in the bottom left will be the low-profitability, least valuable customers.
Once you categorize all of your customers, you will find that they fit into one of the four pictured quadrants. They are labeled as core, opportunistic, service drain, or marginal customers.
- Core. These customers are key to your business. The goal should be to move all other customers up and to the right toward this core group.
- Opportunistic. These customers are highly profitable but don’t buy a lot from you. Knowing this allows you to focus on selling more to these customers. This is the group of customers you’re trying to grow.
- Service drain. Opposite to opportunistic customers, service drain customers have value, but they’re just not as profitable as they could be. With that in mind and armed with a Revenue Intelligence platform will allow you to drive the profitability of these customers.
- Marginal customers. These are the edge customers. They don’t have a ton of value or net profitability. A whole lot of potential for what you can do with these customers to bring them toward the opportunistic or service drain categories and, hopefully, eventually to the core.
From here, a tool like White Cup Pricing’s customer stratification tool will break down these four customer categories for you, showing you high-level information like the number of orders and products in each customer category, historical data like total revenue and override percentage, and guidance on your pricing optimization progress. More enticing is the “opportunity” data, shown simply as the total amount of money you can stand to make per customer group year over year.
For instance, you may see that the service drain customers have the potential to bring an additional $2.1 million in revenue. Meanwhile, the opportunistic customers have the potential to bring in another $400k in revenue. That’s $2.5 million straight to your bottom line. It’s done by closely examining your customer base, as we mentioned before, and intentionally shifting your focus toward specific accounts that need specific attention and action from you as a distributor. Again, this opportunity data is revealed within just one of White Cup Pricing’s many pricing optimization tools.
Take Action
This is what you should do with every one of your customers. Determine if you’re stretching your relationship and trying to improve it. Try to protect that relationship from the competition. Ask yourself if you need to examine the customer and really understand what’s going on. Eliminate customers that are causing more harm than good (the scary one that nobody wants to talk about). Develop relationships with customers that have greater opportunities.
For each of the customer types, you’ll want to take a different approach.
Core: Stretch and Protect
This is key to the success of the organization. The customers that fall into this group are making up close to 80% of your profit in some cases. You could possibly only focus on this set of customers and be a more profitable organization. Obviously, you want to grow. You want to expand your market share. So, then you also want to work on opportunistic customers.
Opportunistic: Develop
This is the one you need to spend time with. They are profitable customers for you. They provide you profit when they buy, but they’re just not buying a lot from you right now. You need to ask a few questions. Is the thing they’re buying overpriced? Are you able to enter contracts with them? Are you able to move them into a longer lifetime value where they’re buying more from you and moving toward the core category?
Service Drain: Examine and Develop
You need to understand precisely why they’re draining the organization. Why is there a higher cost? They are buying a lot from you, generating revenue and cash flow, but they’re just not that profitable. You also want to continuously develop this relationship because the right tweaks will bring them right into the core category.
Marginal: Examine, Develop, and Eliminate
Some of the customers in the marginal group are not buying a lot from you and are not profitable. Some of these customers may just call you when their main distributor doesn’t have the resources of the product available, so they turn to you looking for a discount—saying they’ll buy from you in the future. You need to examine their behaviors and eliminate customers as necessary. Furthermore, there might be a customer in this category that needs a little bit of development effort so that you can nurture them over time toward another customer category.
White Cup offers a revenue intelligence platform with integrated solutions specifically designed for the distribution industry. Our CRM, BI, and Pricing software is the complete revenue engine for distributors. It is laser-focused on driving more revenue and improved profits. With decades of industry experience, White Cup is trusted by more than 1,000 customers globally.
