Are Many of Your Customers Unprofitable?

In the new Summer 2011 issue of MIT Sloan Management Review, marketing scholars V. Kumar and Denish Shah report some intriguing findings from a study they conducted linking certain types of marketing techniques — those aimed at increasing customer lifetime value (CLV)  — to stock price increases. 

As part of their research, Kumar and Shah analyzed two companies’ customer databases — companies they refer to as “TechInc” and “FashInc” in their article.  (You can read more details about the authors’ research and findings in their article “Can Marketing Lift Stock Prices?”)

What Kumar and Shah found about customer profitability should give many executives pause — even if their companies aren’t publicly traded:

“In both TechInc and FashInc, we found an extremely skewed distribution of customer profitability — which was consistent with our expectations…. The average CLV [customer lifetime value] of one of TechInc’s High CLV customers was about 25 times as much as that of one of the company’s Medium to Low CLV customers. Interestingly, at both companies, the top 20% of customers contributed more than 90% 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 meant the 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 both of the companies the researchers studied, one-fifth of customers accounted for more than 90% of the company’s profits, what does that imply about the remaining four-fifths of the companies’ customers?

And 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?