Thinning the Herd: Letting Go of Unprofitable Clients

As entrepreneurs, we’ve come to accept that being our own boss isn’t always peaches and cream. We deal with dreaded tasks and chores (bookkeeping, anyone?), and service difficult clients. With some savvy delegation, we unload onerous chores on others. It’s harder to unload the onerous clients or customers. After all, they provide the income so we can pay our bills.

Or do they? Sure, they provide revenue; but sometimes they incur greater expenses. And when that happens, you need to reconsider their value to your business. If a client is not profitable and they are difficult, it may be time to fire them.

How do you know if a client is profitable? And how do you decide to let them go?

(Who are your clients anyway? If you sell wholesale, a client is your customer: the restaurant, market or distributor. A farmers’ market can be a client; it’s an aggregate of many individual customers.)

Profitability isn’t just making money from them. It’s also avoiding expenses and keeping yourself open to making money from other clients/customers. You can measure profitability from four different perspectives:

• Does the client generate enough revenue to cover the expenses incurred servicing them?

How much does it cost to attend a farmers’ market and how much revenue does it generate? This is pretty easy math, and you can track it in QuickBooks. The expenses include the market fees, wages for the staff, fuel to drive the truck to and from the market, as well as the cost of growing for your products. A caterer has food cost, payroll, as well as rentals and décor. As you think about your expenses, don’t forget the value of your time!

Depending on the nature of your business, it may be difficult to estimate the value of your time. In simplest terms, how many hours did you spend servicing the client and what is your target hourly wage? This gives an estimate of the cost of your time.

After you calculate the profitability of each client, you may discover that some are barely profitable or a losing proposition. Before you consider firing them, look back through your numbers and see if it’s possible to improve the profitability. Are you charging enough, doing enough to maximize revenue, and are you effectively moderating your expenses? If so, it may be time to let them go.

• Does the client pay you on time?

A client may be profitable on paper, but if they don’t pay soon after you invoice them, they could cost you more money. This can be especially problematic for large wholesale customers. For example, you sell your tomato sauce to Whole Foods. You calculate the cost of production and distribution; with the negotiated price, you still earn 45 cents on every dollar. You feel pretty good about that! But if it takes 60 days from the time of delivery until you receive payment, you may run into trouble. Your staff still needs to be paid; your vendors require payment in 15 days and could impose finance charges if you’re late; and so on. The result: you may incur interest expenses from an operating line of capital or credit cards. That’s a real expenses resulting from a supposedly profitable client.

Similarly, some clients don’t pay quickly even if you set terms that they pay in 15 days. They may have cash flow or organizational problems of their own.

If delayed payments cause you to take on debt or incur other fees, you may want to reconsider the value of that client.

• How many times do you talk with clients during a day/week/month when you are not generating revenue?

At the farmers market, some customers ask lots of questions, demand attention and then purchase very little. A catering client may request many menu revisions and have many “little” requests. A wholesale customer may require many calls and emails to finalize an order. This time isn’t billable, and it prevents you from earning revenue elsewhere. Further, each communication with a customer disrupts your flow for your other work, and it takes time to transition back to whatever else it was that you were working on.

Obviously, good customer service is a cornerstone of good business. And customers deserve our attention. But if they demand more attention than their potential for profits, then it might be time to let them go.

• What is the opportunity cost?

After exploring the previous three measures of profitability, you decide all your clients are profitable. That’s great! But there’s one last point to consider: if you weren’t busy with your current stable of clients, could you be generating greater profits?

As you look at the profitability of different customers and markets, you will likely see that some are more profitable than others. As a caterer, some events may generate a 35% margin, while another only generate 10%. By providing service to the “10%” clients, do you miss out on more “35%” clients? Similarly, one farmers’ market may only generate a few hundred dollars in profits whereas another may generate over $1,000. Do you limit yourself by attending less profitable markets?

Bottom Line: By measuring and analyzing the profitability of each customer and sales channel, you increase your profitably. You ensure you work with the right mix of clients, rather than increasing your customer base increase profits. It’s the epitome of working smarter, not harder.