There are a few candidates for title of the most useful framework in strategy dynamics – and this is sure one!
The “quality curve,” lays out the quality profile of individual items within a certain type of resource. It shows how much each item – each customer, product, employee, etc. – contributes to some important measure of quality.The upper part of the following figure shows an example, constructed by showing first the revenue from a company’s largest customer, then adding the revenue from the second largest, the third largest, and so on. At the far right is the very small revenue contributed by the smallest customer.The size profile of a customer base can vary widely, from a quite balanced distribution, where customers differ little in size, to highly skewed, where the few largest customers dominate the company’s revenue, and a long “tailof small customers contribute very little. Such differences can reflect either features of the market or deliberate policy. An insurance company, for example, developed a product aimed at households in the second quartile of income (i.e. 25 % of households earn more, and 50 % earn less). The income distribution within this band is not especially wide, so the largest customers’ policies were not many times larger than the smallest. Conversely, a skewed distribution could result if, for example, management decided to move from a history of serving smaller customers by chasing a few large deals.A strategy for improving equipment reliability.
Most companies would benefit from knowing the shape of this curve, and from an explicit policy for how they wish it to develop, covering the three classes of change highlighted earlier — adding (or losing) larger customers, losing (or adding) smaller customers, and seeking to grow existing customers. It is useful to develop equivalent quality curves for other resources too, such as the productivity of individual employees in a team, market-reach of distributors, numbers of customers attracted by separate products in a product range, and reliability of individual items of equipment [see briefing 28].
Similar pictures can be helpful in voluntary organizations and the public sector, for example the varying contribution of funds from donors to charitable organizations or political parties, the rates of illegal activity committed by criminals, and so on.
Before deciding how to drive change in the quality profile of a customer base, it is important to note that customer size is not the same as customer value, so we need to distinguish customers’ contribution to sales volume or revenue from their contribution to profitability.
As you can see in the lower part of the figure, this ordering of customers by profitability may not match the size-order for various reasons:
- larger customers may press for lower prices, so although their size is large, the profit margin on their purchases is low
- larger customers may expect higher levels of service, which incurs more cost and again depresses profitability
- larger customers can be more complex to serve, again raising cost and reducing profitability
But BEWARE! It is vital to deal properly with overheads in this analysis or you can end up making things worse rather than better. Closing customers between “D” and “B” above will not remove the need for these kinds of cost, so it is vital to know by how much total costs will actually be cut if such a rationalization is to be carried out.
Until next time…
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Don’t accept the quality curve as given
It is tempting to interpret the profit quality curve as saying simply “close down unprofitable customers to the right of D and profits will jump from C to E” However, in addition to complications caused by cost allocation, there are several further reasons to investigate before taking such simple actions.
It may be possible to develop loss-making customers so they move over to the left of D. Banks, for example, accept young adults as unprofitable customers in the knowledge that they will become profitable as they mature and enjoy rising incomes.
Customers may be linked. That bank may incurr losses in serving that same young customer, but it would be careless to close their account and risk upsetting their millionaire parents!
Finally, it is often possible to challenge fundamentally why the curve is the shape it is. Simplified and cheaper ways to serve smaller customers could enable viable profits to be made that would not be possible with the full-service business model. This effectively skews the right-hand end of the profit upwards. Such differential service models are common in many industries, from telecoms and IT support to industrial equipment supply — indeed customers may be divided into several bands, rather than just large versus small.
This briefing summarises material from chapter 5 of Strategic Management Dynamics, pages 264-267.
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