2.1 The customer selection decision
An important strategic decision, in addition to which products or services to produce/provide, is which customers to deal with and on what basis.
In any organisation, not all customers can be considered equal in terms of the size of their actual or potential purchases (and profitability) and the demands they place on the organisation’s resources.
Market segmentation provides a means to identify which existing and potential customers the organisation should focus on. However, even within market segments, some customers will be considered more important than others and it is necessary for an organisation to decide which it should focus its attention on. This is an aspect of relationship marketing.
Customer relationship marketing (CRM) describes the need to ‘establish, maintain and enhance relationships with customers and other partners at a profit, so that objectives of both parties involved are met’ (Grönroos, 1994, p. 348). Even in the simplest way of looking at exchanges in the for-profit sector, there is a range of possibilities. At one extreme, there are what are referred to as transaction-based exchanges: here, buyer and seller simply exchange products and services for money and at the end of the exchange there is very little likelihood that they will do business with each other again. A one-off purchase from a mobile snack bar at the annual fun fair could be an example. The two parties do not need to trust each other as they immediately see what each side is getting in the exchange, and after all if they have never met before and are not likely to do so again, what basis for trust could there be?
At the other end of the continuum are very long-term exchanges that will perhaps span many years. These may well involve people making promises to each other and they will probably require substantial levels of trust, in addition to a contract and monitoring of performance. Such long-term exchanges are often referred to as being ‘relationship based’. Building long-term relationships with customers is considered to be particularly important in many professional service organisations, such as law or accountancy firms. But long-term external buyer–seller relationships can also exist in the non-profit sector – for example, people who give regular donations to their favourite charity.
It is, therefore, important for an organisation to decide what kind of relationship, if any, it wishes to have with its customers. It is possible to categorise customers on the basis of the costs and subsequent profit that a relationship would generate. This is shown in Figure 1.
For a commercial organisation, the extent to which it should enter into a relationship is likely to be determined (in large part) by the potential profitability of the customer. Customers can be categorised into four groups:
Sleeping giants: these customers generate a lot of profit, and are undemanding and do not necessarily want much from the relationship.
Power traders: these customers provide a large amount of profit but are demanding in their needs.
Pets: these customers produce a small amount of revenue and have no real need for a relationship with the organisation.
Delinquents: these customers provide little profit but are the most demanding in their needs for a relationship. The most difficult group to deal with is the ‘delinquents’. In some instances it will not be possible to remove these customers and they will have to be dealt with. In these instances, opportunities should be provided to allow them to access products/services that are less likely to upset them. If this is not possible then the organisation will simply have to accept that they exist and find ways of coping with their behaviour.
One important aspect of customer relationship marketing is key account management (KAM). But as Millman and Lucas observe, one of the most problematic aspects of KAM is devising and making operational, meaningful criteria for key account definition and monitoring of performance.
Ten customers represented about fifty per cent of our sales last year. Five years ago it was about thirty customers. We can’t afford to lose any of them. Yet I often wonder whether our tender loving care is misdirected and costing us an arm and a leg.
(Financial Controller of a US software company).
They cite this (p. 12) and numerous similar comments extracted from their research, as reinforcing the assertion that effective KAM needs to be underpinned by sound financial data and the use of appropriate decision-support tools. These comments raise the following questions:
- Does the KAM activity add value to the operations?
- Are the returns from individual accounts commensurate with the costs incurred in serving them?
- What measures should be used to assess key account relationships?
- How can the joint efforts of marketing/sales and accounting/finance managers be brought to bear on KAM to enhance best practice?
Millman and Lucas report the following insights gained from their research into KAM practice which tend to be overlooked by marketing/sales managers who rely largely on intuition rather than systematic financial analysis of customers.
- Blanket measures of performance (e.g. target return on sales/investment) may grossly distort the value of individual key accounts to the selling company. Key accounts at different stages of relational development may require different approaches to performance measurement. The best way to monitor performance at the early stages of building a key account relationship might well be customer share growth and cash flow rather than a punitive financial ratio that will demotivate those people tasked with account development and penetration.
- Attribution of customer-related costs has been noted as one of the main stumbling blocks in key account profitability analysis.
- Service and support costs vary with customer order size, type and mix. Some customers are more demanding than others and they often attempt to shift responsibility for support on to the selling company beyond reasonable limits. There is much work to be done in analysing the cost trade-offs associated with varying levels of service/support, escalation procedures, and charging for special treatment previously regarded as free.
Section 2.1 has discussed the customer selection decision which is necessary because some customers will be more attractive than others. This has implications for the basis on which the organisation wishes to deal with any particular customer – if at all. An important factor in for-profit organisations is the actual or potential profitability of the customer. Management accountants have an important potential role to play in determining customer profitability as discussed in the Section 2.2.