Making Cents — Finding the Profitable Ones

September 26, 2011 - 11:57

As gas prices at the pump eased a bit during the summer, consumers gained more confidence and, coupled with recent reports of unemployment easing a bit, have spent more than most economists expected through the 2nd quarter this year. The interesting thing, however, is that paychecks are still shy of where they were at the 2008 peak. The paycheck gap is the result of job losses, loss of overtime and wage cuts put in place during the recession.

Government Action
So what has allowed consumer spending to surpass its previous December 2007 peak? In large part, cash paid by the government, especially the money that kicks in when economic troubles hit. These automatic stabilizers, such as jobless benefits and family assistance, help mitigate the impact of a recession. Specifically, government transfer payments to wages and salaries (excluding Social Security, Medicare and Medicaid) to the tune of $332 billion, providing money to keep consumer spending rising, if only weakly, so far this year.

If not for transfer payments, the household sector and, in turn, consumption would have fared much worse. Something for the fiscal negotiators to keep in mind during their debt ceiling conversations. Fiscal conservatives, however, don’t want to recognize the importance of government help when it comes to the unemployed. Some spending critics even question the efficacy of fiscal stimulus and whether government action did anything to alleviate the pain of the recession.

When it comes to consumer incomes, the answer is yes. Without transfer programs, such as jobless benefits, the recession would likely have been longer and deeper. Given how weak wage growth remains, a case could be made that absent government help, the recession might not even be over. Nonetheless, consumers are spending, but the real question is what are they spending on?

Capturing Mindshare
At this year’s Seeley Conference, we were considering the issue of consumer mindshare. Mindshare is just a marketing term for the amount of talk or mention generated by a product within the public or media. The goal of companies is to have customers think of their products or services before competitors.

For example, most consumers may think of McDonald’s when asked to name a fast food restaurant, or Nike when asked to name a running shoe company. When consumers think of flowers or other ornamentals, who do they think of? Get my point?

The issue of mindshare is much more important than market share since no one firm in the green industry is large enough to dictate terms of business, particularly price. Thus, mindshare becomes a metric most firms should include in their annual scorecard. As firms do a better job of differentiating themselves in the marketplace, clearly articulating their value proposition, they find themselves in better position to capture mindshare and thus increase sales.

Of course, for our industry it has been a mixed bag depending on what part of the country you hail from. Even firms that are doing things right and clearly articulating their value proposition have had it tough — mainly due to the weather. Either it has been too hot or too cold, too wet or too dry. Not really anything new for our industry, except for the extreme divergence of conditions this year across the country. A few areas had ideal conditions (and firms in those areas made some good money), but for the most part, many firms in the green industry struggled again this year as the weather slogged on deep into spring. Things have been so tough in certain geographies that I anticipate another wave of structural changes (mergers, acquisitions, exits, and strategic partnerships) in the industry again this fall, depending on how leveraged these firm were.

Skewed Profitability Distribution
Of course, the flip side of the mindshare issue is whether or not all of your current customers are profitable ones. In an article I read recently in the summer issue of Sloan Management Review, researchers found an extremely skewed distribution of customer profitability in companies they studied (which was totally consistent with what I would have expected). The average CLV [customer lifetime value] of one of the “High CLV” customers of the firms studied was about 25 times as much as that of one of the “Medium to Low CLV” customers.

Interestingly, at each of the companies, the top 20 percent of customers contributed more than 90 percent of the company’s profits, because each company also had a sizable proportion of customers on which it lost money. The skewed customer profitability distribution means that companies should apply different marketing strategies to customers in the High CLV segment than to those in Medium to Low or Negative CLV segments.”

If, at each of the companies the researchers studied, one-fifth of customers accounted for more than 90 percent of the company’s profits, what does that imply about the remaining four-fifths of the companies’ customers? Is your company any different? Could a small fraction of customers be the source of most of your company’s profits? Conversely, do you know which of your customers are unprofitable for your organization — and how many of them there are?

Hopefully, most of you have conducted a detailed sales analysis to figure these questions out. But I know differently. Sure, most green industry firms in my experience rank customers by sales, but few go the extra step to rank customers by profitability. Ironically, not all of our largest customers are our most profitable customers. But unless you do the math, it’s hard to show you the money.

About The Author

Charlie Hall is Ellison Chair in International Floriculture in Texas A&M University’s department of horticulture. He can be reached at charliehall@tamu.edu.

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