"All animals are equal. Some animals are more equal than others." - Animal Farm by George Orwell
To paraphrase Orwell, I would have to say that all Customers are equal in many respects. But revenue-wise and risk-wise, some Customers are more equal than others. As many of us know, Pareto's law holds quite true for most business situations. I have yet to run into a major company where 80% of revenues did not come from 20% of the customer base.
What this means to me is that the old saying "Treat your customer like a king" really needs to look at the size of the customer's kingdom. Although customer service should still stay paramount, the way you handle the customer from quote-to-cash should be well defined. This is where customer segmentation comes into play for all working capital management and supply chain functions.
From an end-to-end working capital perspective, I would suggest that customers be looked at and segmented along these lines:
1. Revenue and Gross Margin factors: First, look at and divide up your customers in terms of how much they contribute to your revenues and also how much margin they generate for you. High revenue, high margin and low volume customers need to have different strategies applied for doing business than high volume, low margin customers. Also, this detailed segmentation will allow you to apply different pricing procedures to maximize overall revenues. For example, you may typically create different pricing tiers for different custoemr segments. By the way, the retailers use a metric that is useful called GMROI (Gross Margin Return On Investment) ot help do this.
2. Credit Risk: Now this has been done for years. Clearly not all customers have the same level of credit risk. A flexible credit scoring model and access to external bureau data and internal payment history is critical here. After all, if a customer places a sizeable order, but never pays your bill, you may as well have burned the money that you put into building and shipping that product. Credit risk needs to be closely gauged and reviewed on a periodic basis.
3. Collections & Accounts Receivable Risk: This is the back end of the transaction. How do you really go after different customers when their accounts go past due? Do you mobilize your collections staff and burn up the phones? Do you send friendly reminder letters or scathing dunning letters? When should you chase them - 15 days past due? 30 days past due? etc? Do you want to avoid pissing off a burgeoning customer that will probably end up buying millions of dollars from you next year? It all really depends on the customer segment. And if you use these tactics judiciously, you can really keep your DSO from ramping up and maximize your working capital efficiency.
4. Inventory Liability Risk: Whether or not you have contractual liability in place regarding inventory with you customer or not, you definitely want to be aware of how much it costs to service a customer, how they react and how reliable they are. You have to look at inventory turns specific to customers, average days supply of inventory, average variation in the demand forecast, the cost of the inventory (inclduing carrying costs, stockout costs and liability costs), etc... The reason for the big inventory buuble in the early 2000s when a bunch of electronics suppliers got stuck holding the bag on millions of dollars worth of inventory was because they failed to clearly understand the viability and reliability of their OEM customers. When the tech bubble burst, clearly dropping demand would force OEMs like Cisco to cancel supply orders. Now many OEMs were hit hard and had to write off tremendous amounts of E&O (Excess & Obsolete) Inventory. But the suppliers had stocked also up and had hard supply pipelined for manufacturing. So because the contracts were so vaguely defined, the suppliers often had to eat the loss for the inventory. And that's huge because most margins for the suppliers were tight, and resell channels for the E&O inventory were little to none. Tying up inventory needlessly really hits your working capital too. Don't even let me get started on channel stuffing...
I'm sure there are a lot more factors to consider when deciding how to treat a specific customer - potential for product development partnerships, potential for acquisition, geographic dispersion, etc...
I'm still looking for the Grand Unified Theory of Working Capital Management which will tie up all of the loose ends.
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