"Customer stratification" may sound like an odd idea in a climate where any paying customer is a good customer. Still, the sales force has at least two issues to deal with: First, who do I call on that will give me an order and pay for it? Second, who should I be calling on, it's one thing to get an order and be paid for it, but has the company made money? Customer stratification answers these questions and many other ones. Customer stratification measures how much business a customer does with us (sales), how profitable they are in gross margins, how loyal they are, and how costly they are to serve (to protect net margins). Each of these dimensions has a bearing on the sales force's questions. Without the right analysis, the sales force can make decisions about who to spend time with and give services based on their perspective of the customer relationship.
This Customer Stratification Webinar video is from the Proformative webainar "Using Customer Stratification and Cost to Serve Information in Your Sales Efforts to Maximize Profits" held on October 9, 2012. The webinar features presentations from F. Barry Lawrence, Ph.D., Program Director, Industrial Distribution Program, Texas A&M University and John Mansfield, Vice President Business Development, Graybar Electric.
Customer Stratification Webinar
John Kogan: We have a number of learning objectives today and, unsurprisingly, they're all around customer stratification and how that can help you improve your customer relationships, analyze your customer relationships, and improve the customer relationships. These are very critical items more so today than probably any time in the last couple of decades as companies are struggling to find customer, serve customers properly, and maintain profitability in these tough economic conditions.
To get us started today, I'd like to introduce Dr. Barry Lawrence. Dr. Lawrence holds the Leonard and Valerie and Bruce Leadership Chair, Industrial Director of the Industrial Distribution Program, the Director of the Thomas and Joan Reed Center, and the Director of the Global Supply Chain Laboratory at Texas A&M University. As a faculty member of the Industrial Distribution Program, he is involved in graduate, undergraduate, and professional continuing education teaching activities, funded research projects, publications, and industry presentations. The teaching activities surround classes in manufacturer-distributor relationships, supple chain management, distributor profitability, and distribution strategy. Dr. Lawrence is a Fellow of the National Association of Wholesale Distributors (NAW) and the author of four books on distributor competitiveness. Dr. Lawrence holds a PhD in information and operations management from Texas A&M University, an MBA from Texas State University, and a BBA in finance from the University of Texas at Austin. He has more than ten years of industry experience in sales and retail business before joining Texas A&M. Dr. Lawrence, thanks so much for joining us today.
Dr. Barry Lawrence: Thank you; howdy everybody. I'm going to talk about customer stratification today and we're going to relate it directly to the cause. Real quick, I'll review the industrial distribution program and I think it's instructive to look at how we're constructed because we follow basically the same process that corporations do. We have our applied research and applied research is where we do projects with companies typically to help them solve problems for themselves and for their customers and so these research projects are focused on creating competitive advantage and they're done with individual corporations. This is a lot like the value proposition development process that corporations go through where they're determining what it is they're going to offer their customers into the future. We engage in that process with these companies.
The knowledge that's created there goes to our masters program. It's a distance-based program and in this program, the students not only use best practices as soon as they're uncovered in the research, but we have rather extensive project work, including a 9-month project where they actually go in and transport their own companies. These can be viewed as the future leaders of corporations, the next generations of directors, vice presidents, CEOs, COOs, and CFOs. In fact, we have in our program at any one time, we typically have even CEOs and CFOs in the program. Even they are determining what the future of the firm is going to be by taking the knowledge that's been developed in the research or other areas where their company is developing their next value proposition and then laying out the strategic plan and putting in motion the activities.
The next level of teaching we do is continuing education, where we teach programs similar to this one to thousands of people per year and these folks are usually branch line managers, mid-level management, the folks that are actually going to make things happen within the firm, and so developing this next set of leaders, this next set that will be your succession plan. So, think of the graduate program as the succession plan for top management and then the continuing as a succession plan for the mid-management and these are the folks that actually execute and so, at this point, we get to see the execution of the best practices.
Then, finally, it goes to our undergraduate students. This is the number one recruited program at Texas A&M University because it takes about nine months to get from knowledge creation and applied research into our undergraduate hands and textbook takes about five years. After we've taught something at three different levels, and this is something all firms should reflect on, is that in academia we say if you really want to learn something, teach it and after you teach something at three levels, you now understand what works and what doesn't work and you know what needs to happen next. For us, that means we go back to the research, working with our partners as we do it. For a corporation, it means revisiting and reworking that value proposition.
Now, an example of research that we've done. In 2006, we did a program on pricing optimization. In that particular research consortium, where we brought together ten best practiced companies to study pricing optimization, we recognized that to do this, we needed, we had to have customer stratification, that it would be over 50 percent of the pricing decision. We did develop it at that time and we've since published a book on it and we've done probably 100 projects on customer stratification since then. What we might not have realized at the time was that customer stratification was actually important to so many aspects of the business, that it was really a much more significant topic than even pricing optimization.
So, in customer stratification, what we wanted to do is we wanted to take an unbiased look at the customer. There is a lot of bias in the dialogues surrounding customers because it gets in the human emotions, feelings, relationships, all of the things that the sales force has to handle on a regular basis. We felt that what the sales force needed more than anything else was an unbiased view of the customer and the best way to get an unbiased view was to extract the information from the information system. So, we looked at what criteria could be used to extract information from the information system. Well, the first criteria that's obvious to everyone is sales logging. How much are you actually selling to this customer? High sales volume obviously means opportunity for margins. It means opportunity for economies of scale. So, there is a great deal of value to this and this is information that your information system collects routinely.
The second criteria was gross margins. This, too, is routinely collected by the system. In fact, the IRS feels rather strongly that you collect this kind of information. And so, the gross margins for the, and this of course tells us high grossly margins is usually a sign of the strong customer.
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The third criteria was the customer life or loyalty of the customer to the organization. This one at first looked like it was going to be complex to draw from the system, but in time, after working with hundreds of business executives and examining what truly constituted loyalty, we were able to determine that this was actually very, very much in the system. And so, what we did is we did such things as looking at the breadths of the products that they bought from the distributor, the number of product lines they accessed, how often they bought from the distributor, were those trends going up or were they going down? And what we found was it was very difficult to find scenarios where a customer could be declared as loyal if they didn't show up on these criteria in a positive fashion. It was possible, but it was genuinely a rare exception and one we felt that the sales force could deal with on a regular basis.
The final criteria is the one we want to talk about today and that was the cost to serve. The cost to serve, of course, runs against the gross margin and between the two, you get your net margin. And so, customers can cost a great deal to serve and this was becoming a very challenging area in topic for the distribution community. Now, if a customer pays high gross margins and doesn't cost a great deal to serve, if a customer is loyal and a customer does a lot of volume, these are what we call the core customers. Core customers, firms find, are somewhere between 5 percent and 20 percent of their customers and they generally provide between 80 percent and 90 percent of net margins. This raises two questions. Question number one is why are we bothering with anybody else and we'll address that question in a few moments. Question number two is how could you possibly survive without the core customers? Maybe that's not so much a question as a warning of the significance of these customers.
The next set of customers are opportunistic customers. Now, these customers tend to pay well. They don't run up cost to serve, but they're not loyal to you and they don't do much volume and they're aware of that. And since they're aware of that, that means that they don't get demanding on pricing or cost to serve. Oftentimes, these are your competitors' best customers, the core customers for your competitors, and they're people that you would like to establish relationships with. In other cases, they're highly technical specialists who only buy one or two at a time. Think of an engineer designing a new product and wanting to get test parts in to try the new product or think of a homeowner laying out the fence for their yard . . ."
End partial; Customer Stratification Webinar