It's called the whale curve -- a schematic representation of profit, replicated below. It illustrates, among other things, how 200 percent of profit can come from only 10 percent of customers. Fifty percent of customers might account for 250 percent of profit. And the bottom half of customers can actually bleed the profits of the firm. Innovation in accounting, called activity based costing of individual customers, has led to this important insight.
What should a manager do with this insight? The more a firm can flatten this hump, the more it will profit from customers who do not bleed the firm. So the question stands: when should a firm fire a customer?
There are a variety of solutions available in each case above. Netflix, for example, could slow down its shipment rate; or banks could spend time educating customers about online resources. Generally, firms might raise prices to account for the increased cost of specific customers. But the essential riddle remains whether or not these actions make sense for profitability.
To examine these tradeoffs, I worked with my colleagues at the Yale Center for Customer Insights, Jiwoong Shin and Dae-Hee Yoon, to develop an economic model based on game theory that clarified the relationships between a firm and its customers and aided understanding of how to improve profitability by flattening the whale curve.
We discovered first that most business-to-consumer markets, like direct marketing and online retail, are structured such that every customer tends to be profitable. There is no need to fire any customers because a firm does not spend differentially to serve them; there are essentially no unprofitably high-maintenance shoppers, except those that have a chronic habit of returning items after trying them out. Zappos is famous for the ease with which it facilitates returns, but can be successful only if most of its customers don't make a habit of it.
But in many business-to-business markets, as well as those business-to-consumer markets that demonstrate differential customer costs (as in the examples above), it makes sense to selectively raise prices for high-cost customers, offer lower prices for low-cost customers, and fire the customers who cost more than they expend.
Interestingly, firms can even benefit from selectively firing profitable customers if the cost to serve them is also high.
A common fear of winnowing the customer base is that the average cost will rise for the remaining customers because much of the cost of doing business (e.g., the staff, the office, etc.) remains fixed over the short-term. We find that this is an unfounded fear. Rather, as long as new and profitable customers come in to replace the old, firms will not only be able to cover the cost of doing business, but find it more profitable.
Our modeling approach shows the usefulness of looking at the whale curve from a dynamic perspective, though traditionally accountants look at this model in static terms. Common practice often strives to expand a consumer base, with the intuitive understanding that more customers equal more profit. Unfortunately, intuitive in this case is not also accurate, and selective customer management can flatten the whale curve over time and increase overall profitability.
Not bad when things are lean. It might just be time to hand out a few pink hued receipts.
We "fire" customers regularly --- We provide what is paid for plus a little more in every transaction. I have learned that despite this it is simply not possible to satisfy everyone and it is a waste of time, money, and emotion to try.
I have never considered the customer to be always right or even just King. Business is a two way street -- Treat the customer fairly, offer good product and service, put a cherry on the top -- BUT -- Understand that not every consumer is a fit for the business and when they cost more money than they generate they are no longer a customer - They are an expense.
Also there is a general equilibrium in everything known as Pareto, in the case of business of a good scale 80% of sales or profit from 20% of customers. Cutting off the tails does not change that reality and overtime equilibrium returns. You will never be done cutting off the tails unless you want to run a completely niche company with few customers that have to be actively managed so they never become outliers.
I just don't see much value on this research.
Given how often the application of game theory has led to the death of a business, my faith in making decisions based on models which use this group of algorithms is not what it was in the 1990s.
The information the model provides is useful, the knee-jerk belief all customers are king should be shaken. When I recall the financial harm Netflix suffered and Verizon suffered and T-Mobile suffered and Deutsche Bank suffered, I shudder to think what harm this information will do to businesses when decisions are made by typical young MBAs who cold-heartedly apply theory while forgetting who actually makes the bottom line possible.
And I wonder if they account for the competition, aka if others do/don't do the same is that a factor in this.
are ruining American businesses.
See: Netflix.
Also, an unprofitable customer may go on to refer multiple profitable ones.
This bean counter mentality is short sighted.
Years ago, I helped a bike shop convert to computer based inventory and sales. After we had every item that was sold bar coded so every sale was tracked, the owner discovered that some of the stuff he had in stock never sold and was wasting space, while some of the parts he sold from his own repair stock were being sold for much less than their market value. After getting rid of SKUs that never sold and re-pricing the parts he sold, his profit increase a lot.
This why Walmart tracks all inventory and sales so tightly so they know exactly what to stock an what to ignore.
As far as "firing" customers I have had to do that when I was the Customer Care manager for a PC company. Some customers just have very unreasonable expectations about technology (and other products). Once I determined our products could never make the customer happy, I purchased them back and sent them to Dell (whose products couldn't meet the customer's expectations either, but they were not shrinking my profits).
i used to have a shopfront pc shop - never again - so many time wasters - they would even eat their lunch in front of me
i used to have a huge spreadsheet price list of 3k items - one column was a hassle factor
can quite see how one could apply similar logic to a customer
in a time business, the art is in u choosing the customer, not vice versa
there are tell tale signs he plans to stiff you - bail at the first signs - i doubt less than $10k is worth chasing in court