The pressure to win business in the distribution and manufacturing sectors is fierce. For many companies, just being able to hold onto existing market share—much less stimulating growth—poses enough of a challenge. Often, business leaders aren’t aware of the multiple ways in which strategic pricing can directly help them achieve their goals–and they are equally unaware of the symbiotic relationship between customer stratification and pricing optimization.
Ever increasing customer expectations around greater product access, best pricing, and expanded services have motivated sellers to become creative in implementing dynamic programs to retain market share and win new business. Companies often use tactics such as mitigating supply chain risk and reducing lead times via reshoring or near-shoring sourcing strategies. Others look to enhance customer onboarding support, after-sales support, warranty, and repair services as potential avenues for creating competitive advantage. Programs such as these are innovative, but they can potentially have far-reaching impacts on the business in the form of hidden costs and adding complexities in execution.
A Disconnect for Leadership
The more a business extends its programs to attempt to win and retain customers, the more important it is that the business understands how its customer relationships align with its revenue and earnings goals. Business leaders need to consistently be informed on how individual customers contribute to growing revenues, reducing sales, support, and service costs as a percentage of sales, and driving greater efficiency in sales asset allocation. This is the premise of customer stratification.
Lack of understanding of how actual financial results are derived from the intersection of customer type and sales strategy, including pricing, is likely fundamental in explaining the results of studies on sales to profits relationships performed by Johathan Byrnes, senior lecturer at MIT and founder of Profit Isle. His analytical experience has shown that:
- 20% of sales activity generates 150% of profit
- 30% of sales activity erodes half of profit
- 50% of sales activity generates minimal profit, but consumes over 50% of company resources
These results indicate that a serious disconnect exists in the C-Suite between strategies deployed and understanding how these strategies succeed or fail in driving financial results across the spectrum of the company’s various types of customers. The customer stratification model provides a framework for analysis that helps bridge this gap and helps to lay the the foundation for strategic pricing.
“Know Your Customer” Through Accurate Segmentation
The phrase “Know Your Customer” is deeply ingrained in the minds of those in the financial sector and is a nod to best practices centered on various analyses and regulatory compliance procedures designed to mitigate risk introduced by customers into the business model.
For those in the distribution or manufacturing sectors, the notion of customer risk may not register concern beyond that of ensuring timely payment from customers. The reality, however, is that customer-associated risk can manifest itself in any number of ways in the running of daily business, thereby, making “Know Your Customer” just as germane for the distributor and the manufacturer as it is for the financier.
When pricing strategy is grounded in accurate information on customer behavior, you can drive both top line revenue growth and bottom-line profit. Before you take out a loan, restructure your supply chains, increase your after-sales support, or create an e-commerce platform, try using the customer stratification method to truly understand how each of your customer types impact your business and to glean insight into devising sales and pricing strategies unique to each type to grow the yield and contribution from all of your customer types.
The model was developed and promulgated by the Council for Research on Distributor Best Practice (CRDP), an alliance between the National Association of Wholesaler-Distributors, and Texas A&M University’s Industrial Distribution Program. Through this framework, customers are ranked against each other in the context of their comprehensive contribution to your business.
With this insight, strategies specific to each type of customer can be devised to enhance and manage customer relationships, strengthen pricing and inventory investment to maximize growth of revenue and profit, and improve the ROI on inventory and sales assets. All this is accomplished while ensuring customers receive the highest level of service and fulfillment and mitigating the risk of customer defection.
Customer Stratification at Work
Key Performance Indicators (KPIs) have been developed as part of the customer stratification model. Those KPIs fall into two broad categories, Customer Lifetime Value and Net Profit Contribution. Each business uses the details in the model to determine how to calculate those KPIs as they relate specifically to their own customers and operations.
Customers are then assigned to one of four categories based on their net profit contribution and their lifetime value to your business. The four categories are:
- Core Customers. These customers are in total alignment with your growth, asset management and profit objectives. They fully appreciate your value proposition. They rely on you for their success, and most likely, you are a preferred vendor to them. Strategies for this category of customer usually revolve around maintaining customer experience and fulfillment and raising customer engagement without increasing the cost to serve.
- Opportunistic Customers. In this category, customers drive satisfactory to exceptional profit for you on a yield basis by way of the high margins and/or the low cost to serve associated with the products they purchase from you. However, their engagement with your company is subpar. Hence, in real dollar terms, they are not your larger contributors to your bottom-line profit, but they could be if you could devise strategies to increase their engagement without sacrificing margin.
- Service Drain Customers. You have high engagement with customers in this category, but due to either unreasonable service demands or the high cost to serve and low margins associated with the type of products they purchase from you, at best they are not generating acceptable return on margin, or worse case, they are eroding the good profit you are generating from other customers. It is imperative to first identify customers in this category that generate profit vs. those who do not, and then understand the underlying reasons why, before attempting to devise strategies to improve the contribution of this customer.
- Marginal Customers. Customers in this category are the lowest contributors in regard to supporting your company’s self-interests. They engage with you sparingly, and when they do, the product mix you maintain to support them generates low margin and/or has a high cost to serve associated with it. Unless a customer in this category is near to becoming an Opportunistic or Core Customer, they likely need to be cut from your sales model.
Once you have assigned each customer to a category, you’ll be able to determine the best marketing, sales, and pricing strategies to retain customers in the higher categories and move customers up from lower categories or out the door.
The Role of Strategic Pricing
There are a variety of approaches that a company can employ to determine optimal pricing strategies. Cost plus pricing is one of the most common. There is also competitive pricing, dynamic pricing, discount pricing, and more. Any of those strategies has the potential to be effective depending on the situation, and it’s virtually impossible to identify a strategy that works in a one-size-fits-all approach.
That’s where customer stratification comes into play. The information derived from classifying customers provides the crucial insights needed to determine which pricing model will most align with each customer type. And, that same insight can be taken back to customers themselves, helping them understand where they have a role in creating a mutually beneficial relationship with your business.
For example, pricing models that make ordering additional products from your business more attractive may be extended to customers classified as Opportunistic–and those same customers can become educated on how increasing their orders can help move them to the Core Customer category, where they would receive even more pricing incentives. On the other end of the spectrum, raising prices for a Marginal Customer may be necessary to account for the impact their purchasing behavior has on your bottom line–and as in the above example, with transparent communications around why prices are increasing or are higher than that customer might expect, that customer can then adjust their behavior in a way that moves them up the hierarchy.
Next Steps: Find the Right Partner
Institutionalizing customer stratification into core business processes, and then applying the learnings to pricing and other strategies that impact the overall customer experience, may be challenging to perform for some organizations, especially in the beginning. However, as data reporting structures are improved, implemented, and maintained, these challenges should mitigate over time.
The guiding rule to follow is to avoid complexity in the model, which can undermine the credibility of the results of the analysis. Complexity can also increase the effort to perform the analysis, where it can neither be performed in a timely manner nor within the frequency needed to keep strategies current and relevant. If a KPI cannot be reliably reported upon, it can be omitted until the proper reporting structure is put in place. It can also be replaced with a KPI of a similar nature that can be reliably reported upon.
Customer stratification should not be a difficult methodology to adopt and deploy. But due to the cost to onboard the process, limitations in legacy tech stacks, or a lack of know-how and experience as to how to best exploit technology, many sellers do find it difficult, and they cannot avail themselves of its benefits.
Sellers who ally themselves with the right technology partner don’t have this problem. The right technology partner can not only provide them access to the right technology but can also teach them the key business concepts underlying the technology and support them in deploying and exploiting it to their maximum benefit.
For more information about customer stratification and ways the model can be leveraged for pricing optimization, download our resource guide, “Growing Profitably Using Customer Stratification.” This free tool provides an overview of the fundamental concepts of customer segmentation models that result in a robust customer stratification framework.
