Fifteen years ago, Tony Pericle, principal at ProfitOptics in Richmond, Virginia, encountered glazed looks when talking to distributors about customer segmentation. Today he estimates 50 percent of distributors have not only heard of customer segmentation but understand the concept and its benefit to the bottom line.

“Segmentation is putting customers into homogeneous buckets,” says Pericle. “You’re taking customers with similar attributes and grouping them together.”

With resources thinly stretched, more and more distributors are using customer segmentation strategies to take a serious look at their customer base and determine which customers are profitable and which ones are not. This process not only reveals the company’s strengths and weaknesses, but also helps sales reps apportion their time among existing customers, as well as identify target markets.

“Customer segmentation gives you a snapshot of your company,” says Barry Lawrence, director of the industrial distribution program at Texas A&M University, College Station, Texas. “It gives you the opportunity to identify where you should be doing business and ensures your company stays on track. It also gives guidance to your salesforce as to how to manage their customers for a more profitable, successful company.”

Grouping customers can be a daunting task, particularly in the jan/san industry where distributors’ products and services touch a wide range of businesses. One strategy is to start small with general groupings and five to 10 operational metrics to keep the segmentation process manageable.
“It has to pass the ‘does-it-make-sense test,’” says Pericle. “If you can’t explain segmentation to your salesforce — the people that are going to be the beneficiaries of segmentation — in 60 seconds, then you’ve lost them.”

Lawrence uses the following four criteria for customer stratification: Customer buying power (represented by sales volume or what the customer is capable of buying); gross margin (often listed as profitability); customer loyalty; and cost-to-serve.

Gross margin together with cost-to- serve, will gauge a customer’s net profitability. Distributors find that this process, called activity-based costing, often leads to unexpected outcomes.

“This is a process whereby a distributor allocates all of his costs in some defendable way to all of his customers and determines who is profitable after that,” says Dave Kahle, president of Kahle Way Sales Systems, Comstock Park, Michigan. “It’s a rigorous exercise, and the results are always the same: One out of 10 customers is profitable, so they subsidize the others.”

It’s not unusual for distributors to find that they’re losing money on their largest group of customers.

“They’re so service-intent that once you start putting a cost to those services you discover you’re losing money on them,” says Kahle. “This doesn’t mean you fire 90 percent of your customers, but it does mean you start to think carefully about whom you’re doing business with.”

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Avoiding ‘Service-drain’: Measuring Customer Profitability