Some customers can remain profitable on an individual basis while making the wider business appear less profitable and less attractive to a buyer.
Some customers can remain profitable on an individual basis while making the wider business appear less profitable and less attractive to a buyer.
This often happens with older customers which were won under different commercial terms or legacy accounts which have accumulated exceptions over time.
The decision to exit them should therefore consider their effect on the wider business rather than their standalone gross profit.
When a customer is dragging down overall margins
Some customers remain profitable because they cover their direct costs, but still sit well below the margin generated by the rest of the business.
This is common with legacy accounts that have not been repriced as costs increased. Over time, they can become a meaningful drag on the company’s overall margin, particularly where they represent a large share of revenue.
The right response is usually to reprice first. If the customer will not accept pricing that brings the relationship closer to the economics of the wider business, management then needs to decide whether preserving the revenue is worth maintaining a permanently weaker margin profile.
This becomes more important ahead of a sale. Buyers will look closely at whether current margins are sustainable and whether a material part of revenue is being delivered on terms that the company would no longer accept for new customers.
Ad-hoc relationships become expensive as the business grows
Some customer relationships become increasingly difficult to manage as the business grows. The customer may have been with the company for years, and the way the account is serviced has gradually drifted away from how newer customers are handled.
While each exception may be relatively minor, they can collectively make operations harder to standardise as the company has to maintain processes around them which do not apply to the rest of the customer base.
This becomes more important when preparing for an exit. Buyers generally want to understand whether the company has repeatable processes which can continue without the founder or existing management team constantly intervening.
Where an important customer still depends on an outdated way of working, management should try to bring the relationship back into the standard operating model. If that cannot be done, the revenue may ultimately be worth giving up.
Cleaning up these relationships before a sale can therefore improve the operating maturity of the business even where it means accepting some lost revenue.
Consider what the customer prevents you from doing
A customer can also become unattractive when servicing the account starts limiting growth elsewhere in the business.
For instance, if the team is already stretched, a customer which requires significantly more work than other accounts can ultimately force the company to turn down better opportunities. If planning an exit, it may also put off potential buyers that were seeking to make the team more lean of integrate a function within their shared services.
The same problem can apply to management time. Some customers remain commercially profitable but require a disproportionate amount of senior involvement to keep the relationship running. As the business grows, that becomes harder to justify because senior capacity does not scale in the same way as delivery headcount.
However, this only becomes a reason to exit where there is a genuine alternative use for those resources. Giving up profitable revenue on the assumption that something better will eventually replace it is unlikely to improve the business today.
Consider customer-level working capital requirements
Some customers are profitable on paper but have longer payment terms or slow collections. The business may recognise a healthy margin on the account while carrying several months of receivables before the cash is eventually collected.
If working capital is already tight, a customer which ties up substantially more cash than the rest of the customer base can reduce the amount available to fund growth and may also make the business less attractive during a sale process.
The margin on the account should therefore be considered alongside the amount of capital required to support it.
To conclude…
Profitable customers should not be assessed purely on whether they make money in isolation.
Instead, management should assess whether the relationship still makes sense for the business the company has become. If the account is consistently weaker than the rest of the customer base and management cannot improve the economics, it may be better to give up the revenue in order to scale cleanly.
This is particularly relevant before a sale, when cleaning up weaker customer relationships can improve the quality of the business presented to buyers.