Thursday, June 3, 2010

Strategic Planning Analogy #329: Different Strategies

Early in my career, I was making a presentation in front of all the senior executives at a company. One of the items on the agenda was choosing the name for a new retail format. After my presentation of consumer research on store names, the CEO started off the discussion by saying he liked store names with the word “Mart” in them (like Wal-Mart or K Mart). His opinion had little to do with the research.

After that, we went around the room so that all the other senior executives could voice their preference. Almost without exception, every senior executive said that they also preferred names with “Mart” in them. Gee…what a coincidence that everyone liked what the CEO liked.

It was at this point in my career I learned that even though meetings can look like a democracy, they can really be a dictatorship. The CEO always got his way, so after that I spent all my time for future decisions focusing on persuading the CEO. I knew that if I got him on my side, the rest would follow like sheep.

It usually doesn’t take people long to figure out who the key decision-makers are in a company. Once that’s figured out, those who want to get something approved focus their efforts on these key individuals. Like in the story, equal effort is not given to everyone. Disproportionate time is given to the executives who are most influential in the decision process. The “Yes-men” and the “Puppets” are basically ignored, as I started to do.

While this seems obvious and natural when working within a company, I have found that many forget this when working outside the company. Just as not all executives are created equal, not all customers are created equal. Some are worth a lot more than others.

Just as we don’t treat executives equally, we shouldn’t treat our customers equally. Our strategies should take into account the variation in customer power.

The principle here is that a “one-size-fits-all” strategy should not be applied equally across all customers. Instead, different strategies (often radically different strategies) should be applied, depending on who the customer is.

Sure, a lot of you may say that you do some segmentation and treat some customers differently. But how radical are those differences in how you treat different customers? Are they as radically different as the customer base you serve? Consider the following data…

Not All Customers Are Equally Profitable
Back in 2001, Hax and Dean, in their book The Delta Project, said that on average, 35% of a company’s customers provide 146% of their profits. Worse yet, they found that about 65% of a typical company’s customers are unprofitable to serve.

A more recent study in 2005 by Deloitte Development LLC found something similar. Deloitte claimed that the top 20% of customers typically provide 175% of a company’s profits. The middle 60% of customers (as a group) were found to be breakeven, and the bottom 20% were unprofitable—often very unprofitable.

Although the figures between the two studies differ a bit, the conclusion is the same...over 100% of your profits come from a small sub-set of your customers. And if you are a typical business, a meaningful percentage of your company’s customers lose you a lot money. That’s a wide variation in customer contribution. Is your strategic approach as varied as your customer contribution?

And things are not getting better. Take, for example, the “freemium” business model used often on the internet. The freemium model works like this: The vast majority of the customers use the basic version on the internet, which is free. A very small subset pay money for a premium version. Virtually ALL the profits come from just those few people who buy the premium version. They need to pay the full weight of the costs for serving the vast majority, who use the product for free.

A good example of the freemium model is LinkedIn. The vast majority of those who use LinkedIn use the free basic version. It is only a small subset who pays for one of the premium versions—Business Version at $24.95 per month, Business Plus at $49.95 per month, and Pro Version at $499.95 per month.

As more and more of the economy moves to the internet—where many expect things to be free—more and more of a company’s profits will come from an even smaller number of customers. In fact, perhaps all the customers will be unprofitable and profits will only come from a small handful of advertisers. At this point, the advertising “customers” who DO NOT use your service (other than as a site to place an ad) may take on far more significance than those customers who use your service, but pay you nothing.

When this occurs, the people who use your product may almost cease to be customers in the traditional sense and instead be seen more as “inventory” to sell to advertisers.

Technology to the Rescue
The good news is that data management technology is getting pretty good at helping out in this process. The data management tools can help us do two things. First, they can help us discover the differences in individual customers. Second, they can help us provide a different strategic approach based on those differences.

Kroger gives a lot of credit for its recent success to Dunnhumby, its technology partner. Dunnhumby helps Kroger understand its customers at a more individualized level, providing insights that create different strategic approaches to its grocery customers.

It’s a different strategic approach than getting a few executives together for an annual off-site strategy meeting. Instead, it involves a room of around 200 Dunnhumby employees (many with statistics PhD’s) working every day, sifting through something like 300 terabytes of data representing 40 billion purchases made during 4 billion shopping trips by 42 million card-carrying Kroger shoppers.

Other Approaches
Not all strategic approaches need to be this data intense. Sometimes, it only takes a little bit of digging to find the key factors that make a customer highly profitable or highly unprofitable. In the freemium model, it is really easy to see who the more profitable customers are—it’s the ones who buy the premium service.

Once you segregate the customers, you can apply different strategic approaches. One can apply a more intensive strategy to appeal to the highly profitable segment, because it will pay off well. Then one can use a lower cost approach on the rest. More value (that is more customized) can be offered to the ones who pay the bills.

Keep in mind, that just because a customer is unprofitable does not mean that they should be encouraged to go away. They can still have value. For example…

1) If all the free LinkedIn customers went away, the product would be far less valuable to the premium customers. Without the free customers, there would be no reason for those premium customers to come to you.

2) Some customers may be unprofitable today, but have high potential later when their situation changes.

3) Even if a customer is unprofitable in total, as long as you can cover your variable cost serving them and make at least some contribution to the fixed cost, they are helping subsidize your business so that you can better serve your best customers.

4) If your model is based on advertising, more money-losing customers can result in more advertising income.

5) In the race to become known as a leader in a category, it helps to have lots of buzz about your brand. The additional positive buzz from unprofitable customers may be the difference between getting to #1 and ceasing to exist.

6) You may lose money giving away samples to key influencers (like mommy bloggers or celebrities), but if they like your product, they will influence a lot of profitable customers to patronize you. Like decision influencers in the office, these people are worth a lot of time to cultivate favor.

So don’t always try to get rid of the money-losers. Instead, use them to your advantage. Also, look for ways to make them less unprofitable—either by using a lower cost-to-serve model with them or by converting them to more profitable behavior. For example, when a profitable customer calls the company, they can get instant personalized service, but unprofitable customers are put at the back of the queue on an automated phone service.

The important thing is that you cannot do any of these strategic options if you do not understand how your customers are different and how that difference impacts profitability.

Customers do not behave the same. Some behave in a way that is very profitable. Others behave in ways that are very unprofitable. These different customer types may require different strategies in order to optimize results. The smarter you are at understanding this (their behaviors, your costs), the better strategic decisions you will make. Recent advances in data management are making this easier and more desirable.

If your strategic approaches become too drastic in their variety, one may need a portfolio of brands in order to deliver the variety of options without destroying a particular brand image.


  1. Gerald, this post provides great insight on customer relationship management. In particular, I like the part on dealing with unprofitable customers. I may add to your list of suggestions the possibility of gluing unprofitable customers in a fashion similar to the way ants glue sand grains together. Telecommunication companies did it by giving a discount to a major dealer who in turn distributes the bulk minutes in fractional minutes to hundreds of small customers. The telecommunication companies used a middle man to glue small customers and alleviate the burden of dealing with “few minutes” customers.
    It is always great to read your posts, Gerald.

  2. Gerald, Great Insights!

    While I agree with the fact that top 20% of the customers might bring most of the profit to a firm, it is equally important to focus on the middle segment (or the so called 80% value consumers) given their enormous buying power. This is where your principle of “one does not fit all” comes in to the picture. Yes, personalization is the name of the game in the next decade – and to start with - why not come up with value brands (that is relevant and accessible to life situations) with “just good enough features” for those 80% of consumers. This type of value strategy definitely reduces the internal cost spine of the firm (good enough quality ingredients + less advertising) and hence increases the profitability as well. In the long run, I will not be surprised if personalization goes to the extent of Made to Order (MTO) level in the next 5-10 years for all product categories as opposed to the current model of mass market production. As we all know MTO is popular in some industries (PC and auto etc) today and it is not that difficult to extend it for other industries if we can build a business case for it.

    In the near term though, the solution perhaps is to come with a three brand strategy – in which every company needs to come up with three variations of the same product (super premium with 100% features/attributes/experiences, Premium with 80% and value with 60% good enough attributes). P&G tide basic is a classic example. The rationale is that in any product 60-80% functionality is often used by the consumers and the remaining 20% are the fancy functions often not used, but makes the super premium consumers feel good from branding stand point and so they are willing to pay the high premium price not for quality - but for the brand prestige.

    In summary, I agree with you that it is important to focus on the top 20% of the customers, but it is equally wise to explore ways to provide best value (with good enough quality) for the remaining 80% of the consumers - mostly because of their buying power to have healthy sustainable profit. This strategy a makes lot more sense especially in developing/emerging economies given the larger percentage of population in the value bucket.