Angel Customers and Demon Customers: Discover Which is Which and Turbo-Charge Your Stock - Hardcover

Selden, Larry; Colvin, Geoffrey

Hardcover

ISBN 10: 1591840074 ISBN 13: 9781591840077

Publisher: Portfolio, 2003

Synopsis

One of the oldest myths in business is that every customer is a valuable customer. Even in the age of high-tech data collection, many businesses don't realize that some of their customers are deeply unprofitable, and that simply doing business with them is costing them money. In many places, it's typical that the top 20 percent of customers are generating almost all the profit while the bottom 20 percent are actually destroying value. Managers are missing tremendous opportunities if they are not aware which of their customers are truly profitable and which are not.
 
According to Larry Selden and Geoff Colvin, there is a way to fix this problem: manage your business not as a collection of products and services but as a customer portfolio. Selden and Colvin show readers how to analyze customer data to understand how you can get the most out of your most critical customer segments. The authors reveal how some companies (such as Best Buy and Fidelity Investments) have already moved in this direction, and what customer-centric strategies are likely to become widespread in the coming years.

For corporate leaders, middle managers, or small business owners, this book offers a breakthrough plan to delight their best customers and drive shareowner value.

About this title

About the Author:

Larry Selden is a professor emeritus of finance and economics at Columbia University Graduate School of Business, a prominent consultant, and an adviser to senior executives in many industries.

Excerpt. © Reprinted by permission. All rights reserved.:

The Trillion-Dollar Opportunity YouÆre Missing What It Meansùand What ItÆs Worthùto Be Truly Customer Centered True Story

A customer of a major money-center bank wanted a mortgage recently. He looked like every bankÆs dream customer. HeÆs a highly active trader through the bankÆs stock brokerage services, paying huge commissions, which are extremely profitable for the bank. He also keeps lots of money in the bank, and those large balances are very profitable as well. One thing he didnÆt do was borrow much from the bankùhis current mortgage was with another institution. Note: Mortgages can be highly profitable for banks. So when the day came that this customer wanted to refinance his old mortgage, he called the bankÆs mortgage department. He was sure theyÆd be delighted to hear from such a terrific customer as him.

It was as if he had called the Bank of Outer Mongolia.
The mortgage department had no idea whether he was a good customer or a bad oneù highly profitable or break-even or unprofitable. They gave him the same treatment and made him the same offer as if he were a stranger who had walked in off the street. He would have to fill out endless paperwork, even though the bank already had much of it. He would have to pay the same fees and interest rates as anyone else. When would the bank make a firm offer of the terms of the mortgage? They couldnÆt really say. In fact, the mortgage departmentùbeing ignorant of the customerÆs history with the bankù couldnÆt even offer him assurances that heÆd get the mortgage at all.

Instead of just being miffed, this customer called the manager of the branch where he has his accountùa manager who knew just how valuable this guy was. Then he patched in a manager from the bankÆs mortgage department. These two managers had never spoken to each other before. DidnÆt it make sense, asked the customer, for him to get his mortgage and get it at advantageous rates in light of his long history and high profitability with the bank? If he didnÆt, heÆd certainly see if some other bank could be more accommodating. ôSorry,ö said the mortgage manager, who explained that his hands were tied. This bank, like most major banks today, is the product of several mergers, and after the last big one all mortgage managers were put on a very short leash until the integration got worked through. He was strictly forbidden to do anything special for this or any other customer. ôWait!,ö said the branch manager, now pleading with the mortgage manager in an effort to keep this customer. ôIÆll pay you the first-year costs of giving this customer a better mortgage dealùjust give it to him! Make him happy! We make loads of money with this guy!ö ôSorry,ö said the mortgage manager. ôIÆm not allowed.ö

The customer got his mortgage someplace else, at an institution that could see what he was worth and was hungry for the business. He gradually began shifting his trading from the Bank of Outer Mongolia to the new institution as well. So the bank not only blew a great opportunity to deepen its relationship with this highly profitable customer, it let a direct competitor take a significant piece of the customerÆs business. And it made the customer angryùa lose-lose deal. Bottom line: a complete disaster for the bank. ItÆs no surprise to find that this bankÆs financial performance is lousy. Its ROE (return on equity)1 is a dismal 10 percent and falling; profits and its stock price have been plunging, and its P/E (price-earnings) multiple is much worse than mediocre, about half the average P/E for the S&P 500. As we write this, the newspapers are full of rumors that the CEOÆs days are numbered.

Sound like any bank youÆve done business with?
Now suppose that instead of this ludicrous, frustrating experience, the customer had encountered something different. Suppose the manager he spoke to wasnÆt in charge of mortgages or a branch but was in charge of him and customers like him. The manager knew everything about the customerÆs relationship with every part of the bank and exactly how profitable he was because this information was available on a computer screen at any time. More important, this manager was accountable for the profitability of this customer and others like him. A few layers up in the organization was an executive whose entire job was to manage the customer segment to which this customer belonged (the bank might call the segment something like ôwealth buildersö). Other parts of the bankùmortgages, deposit accounts, brokerage services, branchesùfunctioned as internal suppliers of products, services, and distribution to this executive and the handful of other executives who were in charge of other customer segments.

Does this sound crazy? LetÆs get really radical: Suppose these segment executives had profit-and-loss responsibility. Suppose the bank could calculate the profitability of each individual customer or customer segment, and these executives were on the hook to deliver specific, budgeted improvements in their segmentÆs profit each quarter.

In this kind of organization, what kind of experience would our bank customer have had? Most likely one that was markedly betterùfor him and for the bank.

This fantasy bank is no fantasy. ItÆs Torontoûbased Royal Bank, which has reorganized its huge Personal and Commercial division in exactly this way. The results have been astonishing. The division has reduced expenses by $1 billion, in part because those product areasùmortgages, deposit accounts, etc.ùare no longer fiefdoms with their own separate administrative infrastructures and their own marketing efforts, which were often aimed in an uncoordinated way at the same customers; everyone in the bank realized that loads of money was being wasted as a result, yet it was virtually impossible to do anything about it. At the same time, the division is ahead of schedule in increasing revenues by $1 billion, a natural result of trying to meet customersÆ total needs rather than trying to sell individual products and services. ThatÆs a $2 billion swing, which the bank is sure resulted from its new approach to business. Because of the bankÆs high fixed-cost structure, most of that money fell to the bottom line. By contrast with the financial performance of the Bank of Outer Mongolia, Royal BankÆs Personal and Commercial division earns a return on equity of about 25 percent. If the division was a freestanding business, we calculate that its excellent profitability and growth prospects would win it a P/E greater than the S&P 500 averageùeven though most banksÆ P/E multiples are way below the average. And the stock of the corporation has outperformed that of most North American financial institutions over the period.

Other than these radically different financial results, whatÆs the difference between Royal Bank and the bank that failed so dismally in dealing with our unhappy customer? Not much, by most criteria. TheyÆre both giant, long-established banks offering a full line of financial services to millions of customers. Both have computers loaded with stunning amounts of potentially useful data about those customers. The most important difference between them is much deeper than matters of size, products, or even the business theyÆre in. It is that these banks conceive of the way they do business in profoundly different ways. Specifically, one of them, Royal Bank, has put customers at the center.

Do You Have Any Unprofitable Customers?
Maybe youÆre thinking, ôThatÆs fine for a bank, but my business is very different.ö ThatÆs just not the case. No matter what business youÆre in, the principles weÆre talking about apply to you. We believe that virtually every company in every industry will soon have to reconceive its way of doing business along these lines, with customers at the center. Why? Because the evidence is overwhelming that this is every companyÆs number-one opportunity to create new shareowner wealth, which is something all companies desperately need to do. Consider: Even when the U.S. economy was booming from 1995 to 2000, most of the biggest companies either failed the most basic test of businessùthey didnÆt earn their cost of capitalùor they passed by the slimmest of margins.

We know for sure that companies did much worse through the slowdown that followed the stock market bust in 2000, despite heavy layoffs, divestitures, and other heroic cost cutting. To put this in the starkest terms: Most companies are failing to achieve what they must achieve to make their share prices rise.

ThatÆs a big problem. In trying to solve it, the typical executive looks for troubles in the companyÆs products or business units or territories, which sounds sensible. But that kind of conventional analysis is no longer good enough because itÆs typically applied to all customers, profitable or not, high potential or low, in the same way. Ever more brutal competition, combined with demanding capital markets and suspicious investors, is challenging managers to rethink their businesses in a fundamentally new way. A number of companies are beginning to do so, using a crucial new insight: If a companyÆs return on capital2 isnÆt much better than its cost of capital, then its trouble is even deeper than bad products or business units or territories. By definition the company must have a boatload of unprofitable customers.

This is a huge idea: A company consists of both profitable and unprofitable customersù angels and potential demons. Some customers are making your company more valuable while some are draining value from it. Not that the demons are bad individuals; frequently theyÆre unprofitable simply because the company doesnÆt know who they are and is failing to offer them the right value proposition. Similarly, managers may be blissfully unaware of which customers are the all-important angels. Combined, your angels and demons determine your companyÆs value. This doesnÆt fit the way most managers run and measureùand thus think aboutùtheir businesses. Yet itÆs obvious that all the profits and value of a company come from its profitable, high-potential customers. If your company has a market capitalization of $20 billion, that value depends entirely on the future profitability of your existing customers and your ability to attract and retain profitable new customers in the future. Thus the first of the three most important principles that emerge from our work and that we will come back to again and again: ,Principle No. 1: Think of your company not as a group of products or services or functions or territories, but as a portfolio of customers.

We will see in almost endless ways why this perspective is so extraordinarily valuable, but to get a basic sense of it, just answer this question: Does your company have any unprofitable customers?

We recently asked that question of the top executives at one of AmericaÆs major retailers. (By unprofitable, we meant failing to earn the cost of capital.) Your answer may well be the same as theirs: No. Amazingly, these executives were quite confident they had no unprofitable customers, even though their business overall was failing to earn its cost of capital. If youÆre baffled by the apparent illogic of this position, well, so were we. Yet this companyÆs leaders insisted that through some dark financial voodoo, millions of profitable customers somehow added up to an unprofitable company.

Our analysis of customer profitabilityùan exercise they had never conducted and werenÆt even sure quite how to conductùshowed them they were wrong. The truth, which shocked them, was that some of their customers were deeply unprofitable. Understand the importance of what this meant: Doing business with these customers on current terms was reducing the firmÆs market capitalization by hundreds or thousands of dollars per customer. Since the company didnÆt understand these facts, it was aiming marketing efforts at these customers and others like them. So hereÆs how absurd the situation was: This company was actually spending money to bring in customers that were reducing the value of the firm.

If you believe your company has no unprofitable customers, we hope youÆre right. But experience has shown us that, like the executives of this retailer, youÆre probably fooling yourself. WeÆve found that most companies have some very unprofitable customersùas well as hugely profitable customersùbut managers rarely believe it or know who they are. In fact, as weÆll see in later chapters, the bottom 20 percent of customers by profitability can generate losses equal to more than 100 percent of total company profits. Even if you know you have unprofitable customers, you may be clueless what to do about it. (ôWe canÆt fire customers, can we?ö some managers ask; the answer is that in some cases you can, as we shall explain, though thereÆs almost always a better alternative. Those demons can often be exorcised.) Yet if a company canÆt figure out a way to earn at least its cost of capital with individual customers or customer segments, itÆs just a matter of time until its share price gets crushed. These days thatÆs something no company can afford to risk.

But suppose your company is fabulously profitable already. Are you immune to unprofitable customers? We doubt it. We have examined the customer profitability of two of the most profitable companies in North America and found that 10 percent to 15 percent of their customers are hugely unprofitable. So even in these cases, managers have an opportunity to make their company still more profitable.

ItÆs crazy so many managers refuse to believe they lose money on some customers. Wall Street analysts should be all over this issue, digging deeply into the facts of customer profitability at the companies they cover, especially at companies that are failing to earn their cost of capital. Yet most analysts arenÆt doing so. In fact, two of Wall StreetÆs top- rated food retailing analysts told us unequivocally there are no unprofitable customers at any of the companies they cover. Little did they know: We had performed analyses at some of these very companies and had found, as we find at every company, that some customers were deeply unprofitable. Yet the news wasnÆt all bad, for we also discovered highly profitable customers at these companies. But the analysts didnÆt have a clue.

A Better Way to Boost the Share Price
These analysts, like most managers, are missing what we consider the most powerful way to understand the true economics and influence the share price of a company: analyzing the profitability of its portfolio of customers. Here we begin to see the second of the three vital principles that leap out from this work and that will be elaborated much more fully in Chapters 2, 3, and 4:

Principle No. 2: Every companyÆs portfolio of customers can and must be managed to produce superior returns for shareownersùmeaning a consistently better than average share price appreciationùnot just to produce earnings per share or EBITDA or revenue growth or customer satisfaction or anything else.

This sounds obvious. Why is it so important? Because it truly is a matter of corporate survival, now more than ever. Capital today travels around the globe instantly, continually, relentlessly seeking its best use. Information about your comp...

About this edition

• Publisher: Portfolio
• Publication date: 2003
• ISBN 10: 1591840074
• ISBN 13: 9781591840077
• Binding: Hardcover
• Edition number: 1
• Number of pages: 256