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Segmenting Your Customer Base:
Size vs. Service

FORM Magazine, March 1989

By PATRICK McMAHON

Having too many customers almost seems like having too many friends — it's not possible. We love to surround ourselves with people who make us feel good and reconfirm our existence. We all like to see ourselves as important, vital people, and one way to ensure that is to claim a large number of friends.

Our businesses, as extensions of ourselves, sometimes follow similar guidelines. Some will measure business vitality by the size of their customer list. But people can get into trouble by spreading themselves too thinly among too many friends. You might be paying attention to the quantity and lose sight of the quality. You might lose a valuable friend because you did not spend enough time fostering that particular friendship. Quality friends take time and effort.

The same is true for quality customers. Our best customers require time, effort and the investment of capital if we are to deliver a competitive package of products and services that meet these customers' wants and needs.

With a business, it is not so much the number of customers that is the real problem, but how these customers are serviced. Treating your customer list equally and democratically can be a problem. Extending costly services indiscriminately across your customer list can only drain that valuable and costly pool of services our companies possess.

Customer segmentation is the ongoing process of ranking your customers according to profitability and then providing a package of services commensurate to that customer's ranking. This subject was dealt with in the FUTRENDS column last month in FORM.

Many distributors and salespeople subconsciously do some kind of customer segmentation. The determining factor may be number of sales calls per year based on account size or a multi-level price list for stock paper based on order size. It is important, however, to develop a written plan about customer segmentation that everyone in the company understands.

The written plan will lead to consistency in how your company handles its customers instead of leaving actions up to each employee. The plan will stress to your employees just how important your "A" customers are and how much service these customers should receive. The plan will also let your employees know how far they should go for their "D" customers.

Why Segment?
Typically, we are small companies. We have obvious limits on our resources. We have limits on our capital. We have limits on our time. We have a limited number of good people. Experienced people are hard to find, and inexperienced people take time to train. Our size dictates that it is vitally important to be efficient and effective in handling our limited resources. We must allocate the right mixture of time, capital and people to those areas or customers offering the greatest return on our investment. Customer segmentation is one way to ensure proper allocation.

We are less than one year away from the 1990s. If we are to believe what we read, we must become sharper and leaner to prosper. Our products are mature; some will become obsolete. Our industry will continue to suffer from overcapacity. Our customers will become more sophisticated and increase their purchasing power. Pricing will become even more competitive, and new channels of distribution will begin to gain market share.

Now is the time to establish closer working relationships with our customers. We must offer new products and additional services. We cannot offer these services to everyone, nor can we get closer to everyone. Instead, we must discriminate. It is today's "A" customer who will likely become tomorrow's "A" prospect for our competitors.

How Do I Start?
The following is a typical list of services offered by forms distributors. The list is divided into basic and extra services. The basic services are offered to all customers. The extra services should be offered discriminately.

Basic Services

  1. Courteous, knowledgeable people to answer the phone and talk with customers.
  2. Prompt order writing
  3. Extensions of credit
  4. Quality assurance
  5. Single source convenience
  6. Delivery
  7. Stocking inventory (stock items)
  8. Purchasing advice
  9. Plant selection-matching of product and service needed

Extra Services

  1. Jumping (dropping everything when the customer calls)
  2. Cash discounts
  3. On-site sales visits
  4. Technical advice
  5. Order expediting
  6. Inventory control
  7. Warehousing
  8. Design assistance
  9. Complaint servicing
  10. Order follow-up
  11. Customer contact with back orders or late ship dates
  12. Multi-level stock pricing
  13. Forms management package
  14. Bill as shipped (custom)
  15. Hand holding
  16. Flexible custom pricing
  17. Pick and pack
  18. Investigating new products at customer's request
  19. Electronic order entry

90/50 Rule
The next step will be to rank your customers based on profitability. I'm sure you are familiar with the 80/20 rule. What is even more relevant for our example is the 90/50 rule. Ninety percent of our profitability comes from 50 percent of our customers. We will start with the 50 percent who contribute only 10 percent to our profitability. We will call this group our "D" customers. The risk is small with this group since these customers account for only 10 percent of our profitability.

The "D" accounts benefit from a solid list of basic services. They will be handled courteously and promptly but will not receive the extra attention needed by the A, B or C customers. On occasion, a "D" customer will require some extra services such as a sales rep's visit or form design. These services can be offered to the "D" customer at additional charge.

On the other end of our list is the "A" customer. This group is made up of approximately 10 percent of our customers who contribute about 50 percent to our profitability. You should bend over backwards to assist this group. These customers should get the best service. When they call, the office should stop and treat them as if they are your only customer. This group might even receive some chargeable services free, such as delivery or warehousing. The time, capital and people you conserve by customer segmentation should be reinvested into this "A" group.

It is this "A" customer who will help guide you in bringing new and varied products and services to your market. This customer will require new products first. He or she will appreciate new services the most. Your "A" customer will be your most valued possession into the next decade.

Every person in your organization should know who the "A" customers are. From salesperson to receptionist, from CEO to delivery person, each employee's contact with an "A" customer should be done with the knowledge that this customer is special. If this group is too large for your company to handle comfortably, you may want to divide it into the A-1s and A-2s.

The "B" customers are just one step below the "A" customers. They too are approximately 10 percent of your customers and contribute about 30 percent to your profitability. (Note that the As and Bs together form the 80/20 rule.) When a "B" customer calls, the office jumps but not as high as for the "A" customer. Remember, we are conserving some of those valuable, limited resources. The "B" customer receives all the basic services and most, but not all, the extra services.

"C" customers represent about 30 percent of your customers, but contribute only 10 percent to your profitability. They receive all the basic services that the "D" customer receives, plus a few extra services, but not as many as the "B" customer.

There is one trap you should be aware of in segmenting your customer base. There will inevitably be a few customers in the lower categories who have the potential to become "A" customers. These potential "A" customers should be recognized and handled accordingly. They cannot be given all the benefits afforded an "A" account, but they should not be treated like a "D" customer, either.

Once your customers are segmented, your company should move customers up the ladder. "D" accounts should be sold on the benefits of becoming "C" accounts, the "Bs" on becoming "As." The benefits of moving up the ladder become real and concrete with clear delineation and a solid list of services for each segment.

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