E-Class #6: How to Diversify & Lock Down Your Customer Base

Transcription

1 #6: How to Diversify & Lock Down Your Customer Base I. INTRODUCTION In your last e-class, you learned how to build systems and processes. Specifically you learned: 1. What a system is 2. Why you need systems 3. Why most entrepreneurs don t create systems 4. What types of/how many systems you need in your business 5. How you can create systems 6. How you should maintain your systems In this e-class, you will learn how to diversify and lock down your customer base. II. LESSON/EXAMPLES A. The Value of a Stable Customer Base Regardless of whether you re building your company to sell it or to run it indefinitely and enjoy the profits, you want to build value in your business. This value will fetch a huge sum of money from acquirers and/or allow you to run the business in a more pleasant manner (versus always looking for new customers and fighting fires like most entrepreneurs do 24/7). One key way to build value in your business is to acquire and serve a stable customer base. Clearly, if you have a stable customer base, you are pretty much assured of a continual flow of revenues to fund the business growth and success. Likewise, this customer base is typically one of the biggest reasons why someone would want to buy your company. So, it thus makes sense that if your customer base could quickly and/or easily leave you and patronize your competitors, that you are operating a high risk/low value business. And that conversely, if customers will stay with you forever, you have built a low risk/high value business. #6 Page 1

2 The key to the latter is diversifying and locking down your customer base. B. The Importance of Customer Diversification and Locking Down Your Customer Base If your company has one or only a handful of customers that represent the majority of your revenues, you might have a problem on your hands. The problem is that if one of these customers leaves you (e.g., they go with a competitor, they go out of business, they no longer need your product/service, etc.), it will wreak havoc your business. Likewise, most acquirers won t show any interest in your business it s just too risky for them. As such, you need to make sure you diversify your customer base. Specifically, no one customer should represent more than 15% of your total revenues. And the more customers you have, the merrier. The next thing you need to be sure to do is to lock down your customer base. What I mean by this is that you need to do whatever you can to ensure that customers won t or can t leave you. The two key methods for doing this are: 1. Building high customer switching costs 2. Securing contractual sale agreements C.. Building High Customer Switching Costs One of my favorite examples of building high customer switching costs was done by a company I patronize called PayTrust.com. PayTrust offers an all-in-one online bill pay that allows you to easily receive, track, and pay all your bills online. I started using PayTrust a while ago, and importantly BEFORE most banks had online services that allowed you to pay your bills online. In setting up my PayTrust account, I had to add the names, addresses, account numbers, etc. for all of my bills. So, my PayTrust account now has all the information for all of my credit cards, my plumber, my utilities (heating, electricity, cable/telephone), my gardener, and so on. #6 Page 2

3 Here s the key: the fact that I have spent so much time over the years entering all of this information into my PayTrust account has created a huge switching cost for me. That is, the personal cost to me to switch to one of PayTrust s competitors is too great. It would take me hours to copy over all of my information, which I really don t want to do, particularly if doing so (e.g., going to a competitor) would only save me a few bucks. (Also note that most of my bills are directly sent to PayTrust s address in North Dakota, so I would have to contact each of my vendors and get them to switch the address which would be a total pain). The lesson and question is this: what can YOU do to create switching costs for your customers? Here are some examples of switching costs: Time Switching Costs: If someone uses an ipod and has their entire music library in itunes, it s going to be really hard to get them to move or import their entire music library into a new system required by a different mp3 player. Learning Switching Costs: I have spent a lot of time learning how to use our company s customer relationship management (CRM) system. Moving to a new system would require me to spend more time than I d want to learn how to use it. So, we re not changing anytime soon. Network Externality Switching Costs: Network Externalities occur when the value of a product or service increases as more people use it. For example, wasn t that valuable when only a few people had it (since they could only send s to a few people). As more and more people used , its value increased exponentially. Monetary Switching Cost: This is discussed below in contractual agreements. For example, if you try to change your mobile service provider, oftentimes you ll have to pay a termination fee to your current provider. Once again, the question for you is how can you create greater switching costs for your customers so they are prone to stay with you longer? D. Securing Contractual Sale Agreements The ideal scenario for virtually all companies is to achieve contractually recurring revenues with your customers. #6 Page 3

4 That is, customers are contractually required to pay you periodically. Once again, consider mobile service providers which typically lock customers into 2-year contracts that require them to pay a set amount every month, and require a hefty termination fee should the customer wish to switch providers. Acquirers love buying companies with contractually recurring customer revenues because they are guaranteed future revenues, and thus see the company as low risk/high value. Entrepreneurs running companies with contractually recurring customer revenues can run their businesses with much less stress as they too are guaranteed future revenues, and will survive even poor and/or changing economic conditions. The question for you is: how might your company be able to achieve contractually recurring revenues from your customers? E.. Serving the Best Customers The next step in ensuring that you have a great customer base is to make sure you are serving the best customers. In most businesses, the Pareto Principle, or 80/20 rule, comes into play here. That is, in most businesses, 20% of the customers represent 80% of the revenues or profits. It is absolutely critical that you understand what the precise Pareto Principle is in your business (e.g., what % of customers represent 80% of the profits in your business), and that you 1) cater to these customers, and 2) get more of these customers. For example, the customers that constantly complain about your prices, buy the least quantities, and use up your customer service resources are often the worst customers to serve. Conversely, customers who often purchase your premium priced products and services are generally the best. The key is to identify who your ideal or best customers are, what defines them (what demographic and psychographic variables describe them) and then use these variables as the basis for better serving and attracting more of these customers. F.. Serving the Best Customers Over & Over Again Finally, once you acquire these better customers, you want to serve them over and over again. Clearly, the more times your typical customer buys from you, the more #6 Page 4

5 profits you will generate, the less risky your business will become, and the more acquirers will want to buy you. As discussed earlier, the ideal form of customers buying from you on an ongoing basis is developing contractually agreements that require them to buy from you periodically. But, for many businesses, this might not be feasible. Fortunately there are other ways to ensure that customers in virtually any business will buy products or services from you on an ongoing basis. For example, you can offer any of the following to reap ongoing sales from your customers: Subscriptions (magazines generally use the subscription model) Service contracts (I pay my oil provider for a service contract so they will repair my boiler should it break down) Licensing fees (many software companies offer a one-time product payment plus ongoing licensing fees to use the product and access upgrades) Recurring retainers (many firms like PR agencies charge recurring monthly retainers) Importantly, the recurring or ongoing revenue method you use may be a NEW product or service you devise. For example, if you own a hardware store, you may not think that getting recurring revenues is possible. But what if you charged ongoing (e.g., monthly, quarterly or annual) fees for customers to: Get 15% discounts to all of your merchandise? Attend weekly or monthly demos you put together? Receive a newsletter on how to build certain items? Do home walk-throughs to see if they need any repairs or hardware? #6 Page 5

6 III. EXERCISES TO COMPLETE 1. How can you create greater switching costs for your customers so they are prone to stay with you longer? Remember the examples above of time, learning, network externality, and monetary switching costs. Brainstorm and write your answers below: 2. How might your company be able to achieve contractually recurring revenues from your customers? Brainstorm and write your answers below: 3. Are you serving the best customers? Remember, a key to your success is to identify who your ideal or best customers are, what defines them (what demographic and psychographic variables describe them) and then use these variables as the basis for attracting more of these customers. A. Look through your sales records and identify i the customers who generate the most profits and revenues. Write the names of these customers below: #6 Page 6

7 B. Identify I the characteristics (demographics and psychographics) of these customers.. Write these characteristics below: C. How can you reach more of these customers with your marketing (e.g.,( direct mail, cable TV advertising,, customer referral programs,, etc.)? 4. How can you get customers to buy your current products/services more often? What new products/services can your create and offer that lend themselves to ongoing or recurring revenues from your customers? IV. CONCLUSION Diversifying and locking down your customer base builds value in your business and reduces risk. Once you have a large group of customers who buy from you and pay you periodically, your business can run and grow like clockwork. You ll be able to weather economic storms or competitors chopping their prices to try to steal your customers. And you ll have acquirers fighting to buy you which will reap you the highest possible price for your business. In your next e-class, you will learn how to institute the 5 marketing levers in your business. #6 Page 7