I’ve been coaching some new CPA firm owners about how to build a profitable professional services firm. And to jump to the punchline? The twin tricks are avoid unprofitable customers and unprofitable services.
But many of the strategies and tactics apply to any small firm that sells services: haircuts, yard maintenance, legal advice, dry cleaning, construction and so on.
Accordingly, I thought it would make sense to share my coaching comments. And then also some other ideas that veteran managers and entrepreneurs suggest.
In the paragraphs that follow, I’ll sort of talk in terms of a CPA firm… but much what the follows applies to any service business.
But What is Profitability?
Let’s quickly start with definition of profitability, though.
I don’t mean (or necessarily mean) you get small business profits that let you drive some fancy car… or live in some expensive home or condo… or spend lavishly on toys and vacations.
What I mean by profitability is this. Your business, once you get it rolling, needs to pay you and your employees reasonable, competitive wages and salaries. And market-rate fringe benefits.
Your business also needs to pay an extra amount that represents a return on the capital you’ve invested in the business. This might include easily paying the bank on some loan.
Finally, the profitability needs to provide some cushioning. The operation needs to not run on a shoestring.
Let me give you an example of what I mean. And to make the math easy for everyone, I’m just going to use very round numbers.
Example: Assume other organizations pay someone who does your job $100,000 in salary and fringe benefits. Assume your small business requires $100,000 of fixtures, technology and working capital and you want to earn 20% or $20,000 on this investment. Finally, say you want $10,000 a year of cushioning. Profitability in this case means $130,000: $100,000 salary and benefits plus $20,000 return on investment plus $10,000 of cushioning.
And just to say this out loud? Sure. For some folks, profitability means bottom-line profits equal to $50,000. Or less. And then for some folks, profitability equal to $500,000 falls short.
The point is, profitability requirements vary. But a profitable small business pays its owner a salary, a return on her or his investment, and a little extra for cushioning.
The Two Lies Service Providers Tell Themselves
One comment related to profitability, too. You and I want to avoid telling two “profitability lies” to ourselves. Because either lie lets you or me pretend we don’t have the “unprofitable customers” problem. Or the “unprofitable services” problem.
Lie number one goes like this: On paper, a business makes the owner $50,000. But if the owner worked for well-run employer with good customers and clients and good products and services, she would earn $100,000.
In this situation, sure, the business “technically” shows a profit. But the owner actually loses (per the example) $50,000. Annually.
That makes sense, right? She earns $50,000 in her own business. But working someplace else, she would earn $100,000. That $50,000 lost income represents her business loss.
Lie number two resembles lie number one. And it goes like this: The business owner makes $50,000 running his own show. And that number works and counts as profitable. The problem here is the owner may not actually have one profitable $50,000 job but two $25,000 jobs.
In this situation, this owner may be selling his time at a giant discount and then making up the difference by working a million hours. That’s also not profitability. That’s self-exploitation.
And now, with that background, let’s quickly step through the strategies and tactics that small service businesses can often use to solve the unprofitable customer and unprofitable service problems…
Most of these ideas are pretty simple to understand. Note that not all will work or be available as options in every situation… But some large handful of options is often available.
Idea #1: Target Customers Who Understand Profitability
A first simple idea for dealing with unprofitable customers? Focus on and target customers or clients who understand profitability.
In other words, go for the folks who understand costs, expenses, revenue, overhead… and then also the impact of this stuff on the profitability of your relationship with the customer.
Probably this means business clients or customers.
Customers and clients want you and me to stay in business. So we can continue to provide them services. And savvy customers “get” we need profits.
Idea #2: Watch for Early Warning Signs
Something else easy to do? Watch out for any early warning signs that suggest a customer or client relationship may be one you or I want to avoid: abusive behavior, requests for undeserved credits and discounts and free services, general aggravation, or unpredictability.
Some people suggest only twenty percent of your or my customers or clients are actually profitable. (I don’t think that’s necessarily right as I’ll talk about later.) But surely many customers and clients aren’t practical or profitable to serve. So, stay away from the problems from the very start.
Idea #3: Homogeneity Helps
You and I want to do a lot of the same thing. Homogeneity in customers, products and services makes spotting problems easier. Homogeneity lets a firm optimize workflow. And homogeneity means a firm can create “hacks” and “work-arounds” for a smaller list of exceptions.
Note: This is a good place, I think, to mention my favorite fast restaurant, In-N-Out Burger, and a blog post we did to recognize and discuss their excellence: In-N-Out Burger a Masterpiece Business.
Idea #4: Say No to Price Shoppers
Service businesses don’t scale well. You and I get limited very quickly by the hours in a day.
Accordingly, you and I can’t compete on price. And we don’t want to work with people shopping on price.
If someone calls our CPA offices, for example, and the first question is “how much does it cost?” Yeah, we immediately disqualify the person. You should do the same.
A price shopper–someone who first looks at the price–has a high probability of being an unprofitable customer for a service business.
Idea #5: No One-off Projects
In some service businesses, like professional services and construction, clients or customers ask for special, customized projects that no customer or client has asked for before… and probably no customer or client will ask for again.
Almost no customer or client can afford a truly personalized service. Even the ultra-wealthy.
You and I want to avoid these “assignments.” Rather, we want to explore whether an existing service–already well-designed in terms of quality and value–works.
Idea #6: No Customer- or Client-led Design of Products or Services
A related point. Customers and clients should not design the product or service a firm delivers. Or the procedures or systems a firm uses.
Customers and clients design a “non-system” that works for their unique, special circumstances… and no one else… at high cost… and which delivers lower-quality results.
Note: You know a good model for product design? Henry Ford. See this blog post for more information: Henry Ford and the Problem of Customer-ization.
Idea #7: Sell Quality or Specialization
If you and I shouldn’t sell services based on price, how should we sell? I think we have two better options. We can sell on the basis of quality. Or we can sell on the basis of being specialists.
With tax return preparation, for example, one shouldn’t sell the cheapest return.
Rather, sell the more complex tax returns that someone can’t do themselves with TurboTax or similar software. Or sell a tax return for a niche of taxpayers with special issues and concerns.
Idea #8: Renegotiate Value Proposition
A great idea from a Harvard Business Review whitepaper, the Right Way to Manage Unprofitable Customers: For the inevitable low-profit product or service and the inevitable low-profit customer or client, discuss with them whether there’s a way to jack the value your firm delivers and so bump the price and the profitability.
A secondary advantage of this renegotiation? If it fails, the renegotiation can be the way we professionally and ethically and kindly wind up the relationship.
Idea #9: Divest No and Low Profit Customers and Clients
Another idea from the aforementioned Harvard Business Review whitepaper? You may be able to divest or sell or giveaway no-profit and low-profit clients and customers.
This weird reality? Customers or clients you or I can’t profitably serve? They may be great folks for some other “competitor.”
And by the way, the reverse is true too. Some customer or client that a “competitor” can’t profitably serve? That sort may work great for you or me. (See Idea #3 and Idea #5 for the reasons why this might be the case.)
Idea #10: Understand Unprofitable Customers and Services “Chronic”
A final helpful notion, I think. Unprofitable customers and unprofitable services represent a “chronic” problem.
No miracle cure exists. Accordingly, you and I simply need manage and mitigate these problems.
About the 80/20 Rule
If you poke around the web and blog-sphere researching the subject of “customer profitability,” you quickly encounter a theory. That theory? The notion that the 80/20 rule applies.
Restated in terms of customer or client profitability, the 80/20 rule postulates that 80 percent of a firm’s profits flow from 20 percent of its customers. Or from 20 percent of its products or services.
And then the “actionable insight” that falls out of this assertion: You and I need to identify the profitable 20 percent… and then cull the unprofitable 80 percent.
Let me unequivocally state I believe this is nonsense. In our service business, I know that more than 80 percent of our client relationships are profitable. Further, the few percent who are low or no profit?
Often, those clients are in transition. Maybe our firm hasn’t yet moved far enough up the learning curve to profitably serve the client. Or to deliver the service. (Which is our responsibility.)
Or maybe a long-time client is temporarily low or no profit due to some bad luck.
Here, however, is the other side of this issue. And boy is this awkward. Surely some service firms serve mostly unprofitable clients and customers.
So maybe, gosh I think probably, the 80/20 rule applies overall.
But that 20 percent of the market that’s profitable to serve? Smart firms target and capture a big share.
And then the 80 percent of the market that’s low profit or not profitable? Those clients and customers are getting served by service businesses who don’t yet know how to identify, capture and keep profitable clients.
A Closing Thought
A closing thought. The work of building up and then maintaining a collection of profitable services and profitable clients? It takes time. And we all need to show both patience and discipline.
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