Do you know how much profit each of your clients is contributing to your bottom line?
Many tech and service businesses lack a clear view of the profit margin each client generates. You might see revenue for each account, but without insight into the gross profit margin each client contributes, it’s hard to make informed decisions.
This clarity is crucial because without it, you can’t:
- Identify which accounts are being overserviced.
- Pinpoint your most profitable accounts (often, they’re not the biggest!).
- Understand which clients are the least profitable (it’s usually the smallest accounts).
- Assess if a different resource allocation might better serve certain clients.
- Determine future pricing and fee structures.
Typical Challenges
In many small tech companies and professional service firms, pricing is often delegated to sales or account managers, who focus on winning clients—even if it means lowering fees. They might think, “It’s better than nothing!” But without visibility into client profitability, they could be providing exceptional service that’s actually hurting your bottom line by exceeding the hours or resources allocated.
This results in a disconnect between how busy your team is and what your net profit margins reveal each month. Without clear pricing controls, decisions are often based on guesswork, and there’s reluctance to consider necessary price increases for fear of losing customers.
The Impact on Your Business
When client profitability isn’t managed effectively, you’re likely to experience:
- Lower-than-expected gross and net margins.
- Lack of control over your pipeline and cash flow.
- Hesitation around implementing pricing controls, feeling that it’s “too difficult.”
The Bottom-Line Impact of Price Improvements
According to McKinsey, a 1% increase in price can yield an 8% increase in net profits*.
Consider a business with £10 million in revenue and £1 million in net profits. Increasing prices by just 1% raises total revenue to £10.1 million. While this might seem small, that extra £0.1 million flows straight to the bottom line, boosting net profit from £1 million to £1.1 million—a 10% increase.
If you’re looking to sell your business based on a multiple of earnings, the impact is even more significant. At a 5x earnings multiple, your business’s value would increase from £5 million to £5.5 million with just a 1% price increase.
Solution – Customer Profitability Analysis
To gain a clear picture of client profitability, start with a Customer Profitability Analysis:
- Allocate Costs:
- By product or item. If you are selling productised services, you will need to go through a process of identifying and allocating unit costs to each of your core products or items. This can take time, but doesn’t need to be perfect to help you make better decisions in the long run.
- By client or account, especially for labour-based services. Calculate labour costs by dividing total employment costs (including benefits) by 250 workdays and factoring in the utilization rate (e.g., £50,000 annual cost divided by 250 days = £200/day; with 50% utilization, the effective cost rate is £400/day).
- Track Time: Use time-tracking software or simple methods to monitor time spent on each account. Accurate tracking allows you to see the true cost of servicing each client.
- Combine Data: Combine the cost analysis and your client billings in a report (e.g., using pivot tables) to view gross profit in pounds and percentages monthly.
- Rank Clients: Sort clients by revenue, cash and % gross margins identify your best- and worst-performing accounts.
Take Action
If you discover clients with less than 40% gross profit, consider these steps:
- Track costs properly if you’re not doing it at the moment.
- Create management reports that clearly show individual client profitability.
- Increase prices at the next renewal for those clients with low margins.
- Put in place proper pricing controls for sales & account management teams, so they know what they can and can’t do with your pricing.
- Build an internal culture that understands and tracks client profitability, and isn’t afraid to make decisions that are in the best interests of your business.
Conclusion
Knowing your client profitability levels is essential to growing your bottom line. With clarity, you can make informed decisions that strengthen your business, boost profits, and ensure sustainable growth.
If you need any help with this, let me know.