We all know clichés that seem to hold true in business and life and therefore are passed on from generation to generation. One of the most widely used and understood (believed) clichés in the world of business is the 80/20 Rule. We all know it by heart and can cite many instances where it holds true in our businesses:
- 80% of our sales come from 20% of our customers
- 80% of our health-care costs come from 20% of our employee base
- 80% of our productivity comes from 20% of our assets
- 80% of the effectively executed action items come from only 20% of our strategic plan
Take the most important indicator of business success – bottom line profitability. Does the 80/20 Rule hold true there as well? Maybe for some, but our experience working with hundreds of companies of all sizes, from a variety of industries around the U.S., is that another “rule” is far more applicable (and a bit disconcerting) when evaluating profitability. This rule is what I would call the “20/20/55/5” Rule. I know, I know. No one has ever heard of this rule and, more importantly, what in the world does it mean?
First of all, let’s make this easier and just call it the “Cost to Serve” Rule. Still unclear? The Cost to Serve Rule is a key indicator of how your company (if you are like most companies) is utilizing all of its assets to find, serve, and keep customers. And drive results to the bottom line. So, what do the numbers represent? Our experience working with our clients to segment their customer base and then to quantify financial results shows that:
- 20% of your customers account for 115-120% of your net profit
- The next 20% of your customers only add about 5% more to the bottom line
- Incredible as it may seem, the next 55% of your customers are a net wash and add no profit at all
- And lastly, the final 5% of your customers dilute all of your hard work by accounting for net losses of 15-20%
That is the kind of stuff that should keep CEOs up at night and solicit very tough questions from board members and shareholders about strategies and execution. But how many executive teams have ever really quantified this in their own financial statements? Not very many from our experience.
Walker believes to be a high performance company in today’s economy and in the future, you MUST understand the dynamics of the Cost to Serve Rule in your company. Armed with the right customer data and insights, your executive team will have a “playbook” which will allow you to implement highly effective action steps to:
- Retain the first 20% of your customers by continuing to do what you are doing well
- Grow the next 20% of your customers by offering complimentary or new products that meet their needs
- Reduce the cost to serve of the 55% that are a huge investment of assets with no real ROI
- Transform or more likely remove the 5% that greatly reduce your profits and offer no real value
These strategies are derived from truly understanding your customer base, their loyalty, and value to your company. Your team can then truly quantify, not guess, customer value vs. cost to serve. We believe these insights MUST come from your customers directly, rather than through another off-site strategic planning retreat again this year.
I don’t expect the 20/20/55/5 Rule to become a well known business cliché, but I would hope that more CEOs and executive teams will take the initiative to really understand the true dynamics of each customer. More profitable and successful companies will be the result. And one last cliché that I do believe is true: “knowledge is power.”
Senior Vice President