InformationWeek

March 29, 1999

Profitable Customers

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"We decided that we needed to be a more customer-centric business," Winkel says. "We had to find a way to merge that data for a customer view." The bank now uses Lotus Notes Financial Sales Suite, a customer-relationship management package, to extract customer data from its various systems and load it into InfoManager, an AS/400-based data mart system developed by Ferguson Information Systems Inc. and resold by IBM. "Now we can see the entire relationship," Winkel says.

The bank has developed a custom data analysis system for identifying its most profitable customers. Relationship managers use the system to look at accounts and details of individual clients, and develop strategies for better serving profitable customers. For example, they might discover that a customer has investments in CDs and recommend that he or she move the cash to a trust or brokerage product for better returns. Relationship managers are evaluated on their contribution to the bank's profit margin, not on how many products they sell. "The whole goal is knowing who your best customers are so you can treat them accordingly," Winkel says. "Ultimately, this entire business of banking comes down to maintaining more profitable customer relationships, not profitable product lines."

The bank's next step is to address the 10% of customers who are unprofitable, but who have some of the characteristics of profitable customers. "We know who our top customers are and who our bottom customers are," Winkel says. "But we're also identifying the unprofitable customers who should be profitable. The key is to identify why they aren't profitable today."

Grand & Toy, Canada's largest office-supply company, sells directly to business customers as well as through 80 retail stores. Using data from direct sales and business charge accounts at its stores, the Toronto company analyzes the profitability of its business customers using Hyperion Solutions Corp.'s Essbase online analytical processing system and custom modeling and reporting software developed by Clarity Systems Ltd. "You've got to be smarter about who you're selling to, what you're selling to them, and the way in which you're selling it," says John Melodysta, the company's VP of information technology.

Each month, Grand & Toy collects data from its AS/400 billing system, including sales by representative, date, and account. The data is loaded into the Essbase server along with the cost of the products and variables such as delivery, warehousing, sales, and service expenses. Using Excel programs, Grand & Toy analyzes the information to calculate metrics such as gross profit, selling costs, and delivery costs by product category. Factoring in fixed costs, the company is able to calculate the profitability of each customer.

Grand & Toy goes a step further, adding in customer data such as the number of orders, deliveries, and returns, as well as order sizes. By analyzing this information, the company can discover, for example, if a customer is frequently ordering office supplies in small lots, which leads to higher delivery costs and lower profits.

As the Grand & Toy experience shows, one of the biggest challenges of identifying profitable and unprofitable customers is nailing down the costs of providing service to those customers. "A lot of this comes down to allocating spending at the customer level," says Andrew Frawley, president of Exchange Applications.

That's a problem US West is trying to get under control using SAS Institute's Enterprise Miner and Exchange Applications' Valex. For about a year, the phone-service carrier has been analyzing millions of billing records to identify what it calls "high value" customers--particularly those who might be in danger of switching to another service provider--and "high potential" customers, those who could be turned into big money-makers with the right mix of service and marketing, says Dennis DeGregor, US West's VP of database marketing.

US West defines high-value customers by the amount of revenue they generate and high-potential customers by what they might generate. But the company really can't say how profitable each customer is until it begins to examine how much it costs to serve and support those customers. That will require analyzing detailed data about the vendor's network, including switching and infrastructure expenses, and service costs, says Jovan Barac, US West's director of decision-support systems. For budgetary reasons, that step will have to wait a year. "Next year, we'll improve our value-definition to include the costs," he says.

The great payoff for any business is to turn a profit on customers who were once unprofitable. How do you do that? The strategies include selling products and services with higher margins, charging higher fees to cover costs, and shifting unprofitable customers to lower-cost service channels. Fidelity Investments, for example, charges occasional users of its online trading service more than it does active traders.

Turning an unprofitable customer into a profitable one can be a simple matter of behavior modification, such as getting customers to buy the same number of items in fewer orders as a way of reducing processing and delivery costs, says Grand & Toy's Melodysta. The office-supply company has an electronic ordering system that automatically saves up small orders from customers for a day, week, or longer--based on the customer's preference--and then combines the orders into a single delivery. Grand & Toy offers discounts to its biggest customers as incentives for holding down costs in this way.

Even with these measures, some of Grand & Toy's customers cost more to support than they generate in sales. In such cases, the company may slap a charge on all orders it delivers to lower its losses, or even "banish" the customer to the mail-order channel, where they bear all shipping costs.