Concept:
Pareto’s principle as it relates to sales, suggests that 80% of our sales come from 20% of our customers. There is often a presumption, however, that these accounts are low margin because the prices they command are lower than smaller accounts. There are, however, 3 problems with this theory:
- It will cost you a lot more to deal with 10 x £100k customers than with 1 x £1m customer. The cost of selling, administering, order processing, delivery, chasing payments, manufacturing changeovers will all be multiplied by 10.
- 50% of not much is very little in cash terms. 30% of a lot is quite a bit! Cash pays the bills not percentages!
- Have you noticed how smaller customers are well informed these days – even the customers who don’t order much and don’t pay for it once they’ve got it, still expect preferential prices.
Don’t get confused between percentage profit and profit.
Example:
Which would you prefer:
| Account A | Account B | Account C | |
|---|---|---|---|
| Sales | 500 | 200 | 100 |
| Gross Margin % | 30 | 40 | 50 |
Account C might offer 50% gross margin, but that still only equates to an actual gross margin of £50.
Account B is twice the volume and at 40%, offers a gross margin of £80.
Account A has a lower gross margin percentage, but offers an actual gross margin of £150.
If Account C has the potential to grow to the size of Account A, then obviously this would be ideal. Having five Accounts C’s to make up the same sales as Account A, would, however, not necessarily give us greater profitability. The cost of doing business with those five accounts may outweigh the additional gross margin. The manufacturing inefficiencies alone of dealing with five separate accounts may well take up all of the additional benefits of five Account C’s.
We will need to take the following steps to ensure that we get the right customer mix:
- Don’t assume that gross margin percentage is the be-all and end-all.
- Ask your Financial Director/ Controller to work out the net contribution, account by account.
- Target accounts that best suit the mix required for your business.
If we get the accounts mix wrong, then no manner of cost cutting or streamlining will help us maximise our profitability. If we get the account mix right, we have the opportunity to make excellent profits from high volume accounts.