In the entrepreneurial world, recognizing which customers bolster your bottom line is crucial. It’s a common misconception that all customers contribute equally to your success. In truth, some may be sapping your business’s potential. This guide is about identifying your real profit generators and the steps to take once you’ve found them.
Profit vs. Revenue: Not All Spending is Equal
It’s easy to be misled by the numbers. A customer’s high spending doesn’t necessarily translate to high profits. To pinpoint who truly brings in profits, you need to delve into profit margins.
Imagine you have a customer who buys $100 worth of goods each month. If the cost of sales is $40, your gross profit is $60, landing you a 60% profit margin.
Now consider another customer who spends $300 monthly, but your costs to serve them are $250, leaving you with a $50 profit and a margin of only 16.6%.
Here, the lower-spending customer is more beneficial to your bottom line. Spend is a factor, but it’s not the ultimate measure of value.
The Volume Factor
A customer with a high profit margin who buys infrequently may contribute less overall than one with a slimmer margin who buys regularly.
For example, Customer A spends $100 per month at a 60% margin, while Customer B spends $2000 monthly at a 30% margin. Despite a lower margin, Customer B is doubling your profit in absolute terms.
Lifetime Value (LTV)
True profitability often lies in long-term value rather than immediate margins. Customer Lifetime Value considers the total profit a customer represents over their entire relationship with your business.
To figure out LTV, you blend several factors—average purchase value, purchase frequency, retention rate, and profit margin.
Let’s say an average customer spends $100 annually, makes two purchases, with a 50% retention rate, and you have a 50% profit margin. Their LTV would be the $100 average spend times two purchases, giving $200, multiplied by the 50% retention rate, yielding an LTV of $100.
This metric can shed light on a customer’s worth over time, offering a broader perspective on profitability.
Cutting Non-Profitable Customers
It can be tough, but sometimes you have to sever ties with unprofitable customers. Consider the opportunity cost of servicing them. If their business isn’t justifying the effort, it might be time to focus on those who do.
Remember, your time and resources are valuable. Focusing on profit-rich clients allows for a more streamlined, profitable, and fulfilling business operation.
Wrapping It Up
Determining your most valuable customers isn’t straightforward—it’s a nuanced process that involves various metrics, including spend, margin, and LTV.
By carefully analyzing your customer data, you can make strategic choices about where to direct your efforts, optimizing your business’s profitability and long-term success.