Wednesday, March 11, 2015

Profit Centers


It is the rare snow removal and ice management contractor who doesn’t know whether his or her business is profitable. Accounting statements or even the snow removal operation’s tax returns often provide that information. How many contractors, however, are aware that some customers simply don’t make money for their businesses?

That’s right, few snow removal contractors, business owners or managers are aware whether their “best” customer or customers are generating profits sufficient to warrant the degree of services demanded or provided.

Fortunately, the solution is simple: make those customers profitable or cut them loose. Obviously, improving a customer’s value to the business is not an easy task but it usually begins with the discovery of just how much a customer costs.

Keep tabs on costs


The often repeated “80/20” rule states that a large majority (80%) of any business’s earnings come from a very small number (20%) of its customers. In other words, most snow removal businesses make almost all of their money from very few of their customers.

Customers who don’t necessarily generate a lot of income, but who also don’t demand a lot of service may be good customers, while other customers may pay more but require so much assistance that they’re costing the snow removal operation money.

The best way to research a customer and evaluate its profitability is to keep track of all interactions with that customer over a period of time. One week is obviously not enough and an entire season is too long. Most customers’ habits can be tracked within two- to four-month timeframes.

Gross profit margins are the most commonly used factor, but it should not be assumed that a customer is not profitable because its margin is below average. That’s where other factors, including costs, come in.

Many businesses allocate some amount of their overhead costs to customer service. More often, however, costs reflect only the cost of the services performed. Missing from this measurement is the time, support, effort, and ultimately the total cost required to meet the customer’s needs.

Analysis that reveals the total cost by customer rather than by services often produces startling results that will shift the customer profitability discussion from anecdotal or gut feelings to a discussion utilizing quality information.

Cost accounting is the process of allocating all of the snow removal operation’s costs associated with generating a sale, performing a service, etc., both direct and indirect. Direct costs include such things as the total wages paid workers, the salaries of supervisors, supplies expended, etc. Indirect costs are all of the other expenses associated with keeping the operation going.

Establish a system, create a goal


An analysis of customer profitability compares the costs of all of the activities used to support a customer or a group of customers with the revenue generated by that customer or customer group.

Activity-based costing techniques can be used to determine the profitability of customers. Going one step further, activity-based costing can also be used to estimate the cost of doing business with particular customers or with groups of customers that require similar service levels.

When determining customer profitability, it is usually not practical to identify the profitability of individual customers, unless there are only a few of them. Therefore customers may be grouped by size, industries, and market.

To set up an effective cost accounting system, the help of an accountant or CPA might be advisable. Cost accounting can, after all, get fairly complicated. The money spent for professional guidance will be well worth it, leaving only the question of what to do about any “bad” customers.

Turning bad to profitable

The first step in turning unprofitable customers into valuable assets is determining whether the relationship can be improved. A snow or ice removal professional who believes in holding onto every customer, no matter what the cost, may never see the snow removal business reach its maximum earning potential.

Before asking any customer to take his business elsewhere, efforts should be made at “reforming,” the customer. There is no clear rule of thumb. Each situation – and each customer – is different. If the problem is one of slow pay with a small customer, a delay in performing non-contract services might be an option.

The same approach may work for larger customers if the snow removal business has enough leverage. Alternatively, a price increase to offset the higher cost of extending credit might be called for.

Worried about the customer going elsewhere? Sometimes that’s a good thing. Problem customers often become problems for competitors.

Keep profitable customers


It is five times more profitable to spend marketing and advertising dollars to retain current customers than it is to acquire new customers.

In years past the importance of focusing on customer retention was not as important, “stickiness” came naturally. Many of us had a personal connection with our service providers and the thought of shopping at another store, or using an unfamiliar services provider would have never crossed our minds.

That has all changed now. Customer loyalty has disappeared and large corporations and virtual storefronts are forced to ask the millions of disloyal customers what caused them to stray. There is, however, a solution and, once again, it involves costs.

Do you know how much of your business’s resources are allocated to marketing and new customer acquisition? Most importantly, do you know how much you should be spending and at what point it becomes un-economic?

Most small businesses use a combination of guesswork, perceived funds available and gut feel to set their marketing budgets. Understanding the lifetime value of new customers has allowed many snow removal business owners and managers to take a longer-term and more realistic view of attracting new business to make their companies more effective and profitable.

Customer acquisition cost is calculated by dividing total acquisition expenses by the total number of new customers. Not too surprisingly, there are different opinions as to what constitutes an acquisition expense. For example, rebates and special discounts do not represent an actual cash outlay, yet they have an impact on cash flow (and presumably, on the customer).

The specific calculation depends on the nature of the customer relationship which are often divided into two categories. In contractual or retention situations, customers who do not renew are considered "lost for good".

The other category involves customer migration situations. In customer migration situations, a customer who does not buy (in a given period or from a given promotion) is still considered a customer because they may very well buy at some point in the future.

In customer-retention situations, the snow and ice management contractor usually knows when the relationship is over although the firm may not know when the relationship is over (as far as the customer is concerned).

To compute the cost of acquiring a customer (CAC) the operation’s entire cost of sales and marketing over a given period, including salaries and other related expenses, is divided by the number of customers acquired in that period.

In order to compute the lifetime value of a customer (LTV) the gross profit margin expected to result from that customer over the lifetime of the relationship is computed. Gross Margin would obviously take into consideration any support, installation, and servicing costs over the projected life of the customer relationship.

Solutions

There are a number of strategies for resolving the “Best Customer/Least Profitable Customer” conundrum, including:
  • Increasing the profitability of already profitable customers
  • Identifying unprofitable customers and realigning them to better manage costs
  • Pricing services (and products) more effectively
  • Improve internal processes to reliably predict the impact of business decisions on total system costs
  • Improve negotiation processes with customers (discounts, extent of services, prices, payment terms, etc.)

The one thing many snow removal and ice management professionals often ignore is whether their best business decision may actually involve firing some of their worst customers.

While this may seem like an illogical suggestion – particularly in a bad economy – having the wrong customers can be costing the snow removal business in unexpected ways and holding it back from real success with the temptation of short term profits.

The operation may be stuck in a raw deal with minimum profit margins, losing the ability to service new and more profitable customers. The operation may also experience employee turnover due to burnout from servicing abusive or demanding customers, leaving the business with the expense of recruiting and training new workers.

Part of the challenge faced by many snow removal contractors, business owners or managers is how to extract the operation from those relationships without burning bridges or creating enemies (if they haven't already).

Accounting for costs means more realistically pricing services to ensure costs are passed on to the customer.

Cost accounting can also prove invaluable when it comes to determining actual profits, finding out what a particular job actually cost or, if detailed enough, that cost accounting can reveal what your “best customer” actually cost you and your snow removal business.

Mark Battersy is an Ardmore, Pa.-based finance writer and frequent Snow Magazine contributor.

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