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(This post is an edited/updated version of a post I published early last year. With the fourth quarter of 2024 now underway, many B2B marketing and sales leaders will have started developing revenue generation plans for next year. Measuring customer profitability accurately is critical for developing an effective revenue generation strategy. So, this post is particularly relevant now that "planning season" is upon us.)
Key Takeaways
- A growing number of companies are adopting revenue generation programs that treat customers differently based on their perceived value to the company.
- Most companies determine the value of customers based on current revenue and future growth potential, but most don't track customer profitability or use it to judge the value of individual customers.
- The lack of accurate customer profitability information creates a dangerous blind spot. Without it, companies can end up winning business from unprofitable customers.
The Rise of "Account-Based Everything"
The widespread adoption of account-based marketing is one of the landmark developments in B2B marketing of the past two decades. The use of ABM has been growing rapidly since it was introduced by ITSMA in 2003. While the early adopters of ABM were primarily large B2B technology and business services firms, it's now used by a wide variety of B2B companies.
A few years ago, marketing industry analysts, consultants, and technology vendors began to argue that companies should adopt an account-based approach in other customer-facing business functions, including sales, sales development, and customer success/customer service.
This broader application of account-centered techniques was soon called "account-based everything." ABE (or sometimes ABX) is usually defined as "the coordination of personalized marketing, sales development, sales, and customer success efforts to drive engagement with, and conversion of, a targeted set of accounts." (Gartner)
The most rigorous and thorough discussion of this broader use of account-centric strategies and tactics can be found in Account-Based Growth: Unlocking Sustainable Value Through Extraordinary Customer Focus by Bev Burgess and Tim Shercliff. In this book, the authors explain how B2B companies can use account-focused strategies and programs to drive profitable revenue growth.
The premise underlying account-based methodologies is that all customers are not created equal. In most B2B companies, a small percentage of customers account for a disproportionate share of the company's total revenue and profit.
The essence of the strategy described in Account-Based Growth is to identify those "vital few" customers, and then design and implement coordinated marketing, sales, customer success/customer service, and executive engagement programs specifically tailored for those high-value customers.
Burgess and Shercliff explain how to identify and prioritize high-value customers, develop effective account business plans, leverage data and technology to gain deep customer insights, and bring about the leadership and cultural changes necessary to succeed with an account-based growth strategy.
Perhaps most importantly, Burgess and Shercliff emphasize that many companies will need to "radically" reallocate marketing, sales, and customer success resources to effectively support an account-based growth strategy. When you adopt this kind of strategy, you are placing a large bet on the growth potential of a relatively small group of customers and prospects.
In the balance of this article, I'll adopt the Burgess/Shercliff terminology and use the term "account-based growth strategy" to refer to a go-to-market approach that involves identifying high-value customers and prospects and designing coordinated marketing, sales, and customer success/customer service programs to manage relationships with those high-value customers and prospects.
Customer Profitability Is "Missing in Action"
Companies that implement an account-based growth strategy segment their customers into multiple "tiers" based on the perceived attractiveness of each customer. Then, they use different marketing, sales, customer success/customer service, and executive engagement techniques for customers in each tier.
In general, companies will invest more time, energy, and financial resources to develop and execute high-touch and highly customized engagement programs for customers in the "top" tier, compared to those in "lower" tiers. This means, of course, that company leaders must determine which customers to place in each tier.
As part of the research for Account-Based Growth, Burgess and Shercliff surveyed 65 B2B companies. Ninety-two percent of the survey respondents reported having some kind of "top account" program.
When the authors asked survey participants what criteria they use to select accounts for their top account program, 87% of the respondents said the future growth potential of the account, and 76% said the current revenue from the account. These were the two most frequently used criteria by a wide margin.
Customer profitability wasn't among the top five selection criteria identified by the survey respondents. In fact, only 45% of the respondents said their company tracks gross profit at the account level, and only 20% reported tracking net profit by account.
This absence of customer profitability information results in an account selection/prioritization process with a major blind spot. As Burgess and Shercliff put it: "Without this information, decisions about how much to invest in these top accounts and where to allocate resources are being made in the dark."
To make matters worse, many companies that track some form of profit at the account level still aren't getting an accurate picture of customer profitability because the methodology they use to measure customer profitability is flawed.
When you implement an account-based growth strategy, you invest substantially more in some customers than others. It's impossible to make such investment decisions on a sound basis without an accurate view of customer profitability. You can easily find yourself in the unenviable position of successfully winning business from unprofitable customers.
Why Customer Profitability Matters
If all your customers were equally valuable, there would be no reason to implement an account-based growth strategy, and measuring the profitability of individual customers wouldn't be very important. But the reality is that some customers are far more financially valuable to your business than others. There are three main reasons for this value disparity.
The Pervasive Pareto Principle
The 80:20 rule (a/k/a the Pareto Principle) states that 80% of effects come from 20% of causes. One business application of the rule states that, in most companies, 80% of total revenue comes from 20% of the company's customers.
In Account-Based Growth, Burgess and Shercliff argued that the 80:20 rule is nearly ubiquitous, and my experience supports their argument. During my career, I've analyzed sales data from dozens of B2B companies operating in many industries. In most of those companies, I found that the largest 20% of customers accounted for about 80% of total company revenue.
The 80:20 rule has important implications because it is fractal, or at least "fractal-like." By this, I mean that the 80:20 distribution pattern repeats itself as the breadth of data analyzed narrows, like a set of Russian Matryoshka nesting dolls.
To illustrate, the rule states that 80% of a company's revenue comes from 20% of the company's customers, but it further states that 64% of total company revenue (80% of the 80%) comes from only 4% of customers (20% of the 20%).
The implications of this aspect of the rule are profound. Suppose your company has $100 million of annual revenue and 1,000 customers. The 80:20 rule indicates that only 40 of your customers are likely producing about $64 million of your revenue.
When it comes to company profitability, the 80:20 rule doesn't go far enough because the distribution of profit is even more skewed than the distribution of revenue. Companies that accurately measure customer profitability frequently find that all their annual profit comes from a small percentage of their customers. (More about this later.)
The bottom line: In most companies, a small number of customers have an outsized impact on financial performance.
Customer Profitability Varies Greatly
The second reason for the value disparity is that customer profitability varies greatly. When company leaders measure customer profitability accurately, they frequently find that they're earning a lot of profit on their most profitable customers and sustaining significant losses on their most unprofitable customers.
The following diagram depicts the customer profitability distribution found in many B2B companies. In this diagram, the horizontal axis depicts the percentage of total customers, with customers arranged (left to right) by profitability. The vertical axis represents customer profitability. The horizontal line across the middle of the diagram is the profit breakeven point (in other words, $0 profit). The red curved line in the diagram depicts the typical distribution of individual customer profitability.
This diagram illustrates that, in many B2B companies, a relatively small percentage of customers produce attractive profit levels, and a small percentage generate significant losses.
The most sobering point is that customer profitability isn't always correlated with sales volume. In other words, when company leaders measure customer profitability accurately, they often find large customers at both ends of the profitability spectrum. This explains why basing an account-based growth strategy solely on customer revenue is risky.
Customer Profitability Impacts Company Profitability
The third reason for the value disparity is that customer profitability has a major impact on overall company profitability.
The following diagram illustrates how the dynamics of customer profitability affect overall company profit. Once again, the horizontal axis in this diagram shows the percentage of total customers, and again, customers are arranged (left to right) from the most profitable to the least profitable. The vertical axis depicts the percentage of total company profit. The red horizontal line across the diagram is the actual annual profit earned by the company.
When companies measure customer profitability accurately, many find that their most profitable 20% to 40% of customers actually produce between 150% and 300% of total reported company profit. Customers in the middle of the profitability spectrum more or less break even, and the least profitable 20% to 40% of customers consume between 50% and 200% of profit, leaving the company with its actual reported profit.
So, all the profit above the red horizontal line in the diagram is unrealized profit. This is the profit the company earned and then gave away. For obvious reasons, this diagram is often called "The Whale Curve of Customer Profitability," and it dramatically illustrates why customer profitability is so critical to your company's financial performance.
As I noted earlier, companies using an account-based growth strategy segment their customers into multiple tiers based on each customer's perceived value. Then they develop and use more high-touch and highly customized engagement programs for customers in higher tiers than for those in lower tiers.
One primary goal of measuring the profitability of individual customers is to provide business leaders with information that will help them make better decisions about where to place each customer in the value hierarchy.
In Account-Based Growth, Burgess and Shercliff recommended that companies prioritize their accounts based on two factors:
- The "attractiveness" of each account; and
- The competitive strength of their company in/with each account.
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