When it comes to running a business, it's important to focus on the customers that are the most profitable. Not all customers are created equal, and some customers may even be dragging your business down.
In this blog post, we will discuss how to identify your most profitable customers, and the next steps to take once you've established who your biggest profit drivers are.
Differentiate Between Revenue and Profit
Just because a customer spends a lot of money with you does not mean that they generate a lot of profit. To get a clear understanding of who your most profitable customers are, you need to take a closer look at your profit margins.
To do this, you need to calculate your gross profit margin for each customer. This number will tell you what percentage of revenue is left after accounting for the costs of goods sold.
For example, let's say that you have a customer who spends £100 with your company every month. To calculate your gross profit margin, you would take the total revenue (£100) and subtract the cost of goods or services sold (£40). This would leave you with a gross profit of £60.
To calculate the gross profit margin, you would then take that £60 and divide it by the total revenue of £100, and this would leave you with a 60% margin.
On the other hand, if a customer spends £300 per month with you but it costs you £250 to deliver their goods or services, you would be making a profit of £50. Despite the higher customer spend, your profit margin would stand at 16.6%.
In this case, the customer who spends less with you is actually more profitable. So, while customer spend is important to consider, it's not the be-all and end-all when determining who your most valuable customers are.
Sales Volume
However, while one customer may generate an impressive profit margin, they may not necessarily drive a high volume of sales. In this case, you might want to consider customers who generate a high volume of sales, even if their profit margins are slightly lower.
For example, let's say that you have two customers - Customer A spends £100 with you per month and has a gross profit margin of 60%, while Customer B spends £2000 with you per month but only has a gross profit margin of 30%. Customer B is still generating twice as much profit for your business, even though their profit margin is lower.
Consider Customer Lifetime Value
When determining who your most profitable customers are, it's also important to consider customer lifetime value (CLV). This metric looks at the total amount of revenue that a customer will generate for your business over the course of their relationship with you.
To calculate CLV, you need to take into account a number of factors, including the average purchase value, the number of purchases per year, customer retention rate, and the profit margin.
For example, let's say that the average customer spends £100 with you per year, makes two purchases per year, and has a retention rate of 50%. Additionally, let's say that your profit margin is 50%.
To calculate the CLV, you would take the average purchase value (£100) and multiply it by the number of purchases per year (2). This would give you a customer value of £200. You would then multiply this by the customer retention rate (50%), which would give you a CLV of £100.
As you can see, the customer lifetime value can give you a more holistic view of how profitable a customer is likely to be in the long run.
Trimming the Fat
Sometimes, if a customer or client is simply not profitable, you might have to let them go. This can be a difficult decision to make, but it's important to remember that not every customer is going to be right for your business.
Your time, and your staff's time, is a valuable resource. If you're spending too much time and effort trying to service a customer who isn't generating enough revenue or profit, then you may well be better off without them. By focusing on customers who really drive value for your business, you can free up time and resources to better serve your most profitable clients. This helps you to create a leaner and more profitable business that is ultimately more enjoyable and rewarding to run.
Final Thoughts
When it comes to determining who your most profitable customers are, there is no one-size-fits-all answer. It's important to take a variety of factors into account, including customer spend, gross profit margin, customer lifetime value, and more.
By taking the time to analyse your data and understand how different customers contribute to your business' bottom line, you can make more informed decisions about where to focus your efforts - and increase profits in the process.
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