It is a good idea to analyze your customer base each year to determine where you are making money and where your expenses exceed the profit you generate independently on each account.

As a distributor, you have limited resources available to service your customer base. Inventory management is critical, cash flow management is critical, cost containment is critical and a definitive pricing strategy can be your “edge” in creating competitive advantage.

If your organization is not skilled in activity based cost analysis you might try to determine your most profitable customers using a simpler approach. This approach uses basic calculations to give you some sense of where your money comes from and where it goes.

Most of your cash is tied up in inventory and accounts receivable. Consequently, you need to be disciplined enough to ration your cash investments to only those customers who provide a return.

The following steps describe the simple calculation:

Determine the average cost of processing an order in your business. What is your cost to process an order, pack it, ship it, and collect payment? Each of these stages has internal costs that you assume are covered in your pricing matrix schemes. For most distributors, the cost to process one order completely is between $35-50 per order.

Determine key figures for each customer.

1) Total sales

2) Total cost of goods sold (COGS)

3) Gross margin dollars (item 1 minus item 2)

4) Number of orders processed per period

Multiply the number of orders by your estimated cost to process an order. You can use the specific number you calculated in the first step above, or an average provided by your industry association. This cost can change drastically based on the type of product sold and the services provided with each order. However, the $35-50 range would be a good place to start.

Here is a list of Cost Drivers impacting Customer Profitability.

• Number of orders 
• Number of line items 
• Number of quotes 
• Number of outside sales calls 
• Number of inside contacts 
• Delivery miles driven 
• Returned goods 
• Special orders 
• Rules of engagement 
• Overtime required 
• Emergency or hot requirements 
• Speed of payment 
• Demand of price concessions 
• Consumption value added services without being charged

Determine the net profit for each customer. Now that you have multiplied the number of orders by the per-order cost, subtract that cost from the gross-margin dollar figure. Do this for each customer. Consider other costs as suggested by the above list.

The result will be either a positive or negative number. It doesn’t matter if you are 100% accurate in assessing costs as long as you are consistent in applying them across the board. This will provide a comparative “Cost of Doing Business” for your account base selected for your audit.

“Caution ----- Make sure you consider intangible benefits such as “purchasing power enhancement due to high volume purchases before you panic when reviewing the results.”

List the results. List your customers in descending order, from the largest contributor to net profit to the lowest contributor (you will hit the negative numbers quicker than you might imagine).

Not surprisingly the Paretto Rule often applies here also. You may get to zero and negative contribution after about 20% of your customers have been analyzed. It is this remaining 80%that have some negative impact on your bottom-line profits.

Eliminating 80% of your customers based on this exercise is not realistic. However, you certainly might want to analyze how you are doing business with them. Look at all the customers with a negative net profit and determine what their rules of engagement are and what changes can be made to improve profitability.

Before you decide to fire any customers, add to the equation their accounts receivable balances and payment histories. What you may find is that not only are you not making any money on their orders, but you are also financing them with your accounts receivable.

Look at what products they are buying and make sure you are not stocking products exclusively for their account. Unprofitable customers should not get special services.

Once you have determined which accounts are not profitable you have several options:

• Raise prices. 
• Reduce services. 
• Change the pricing matrix so they pay for value added processes 
• Charge for deliveries and add handling fees. 
• Initiate minimum order quantities. 
• Initiate minimum line item requirements.

Rick Johnson, expert speaker, wholesale distribution’s “Leadership Strategist”, founder of CEO Strategist, LLC a firm that helps clients create and maintain competitive advantage. Need a speaker for your next event, E-mail rick@ceostrategist.com. Don’t forget to check out the Lead Wolf Series that can help you put more profit into your business.

www.ceostrategist.com