Growing a business

Avoiding Baker’s Law: Bad Customers Drive Out Good Customers

“It’s axiomatic: You’re as good – or as bad – as the character of your Client List. In a very real sense, you are your Client List!” – Tom Peters, The Professional Service Firm 50

I was recently asked, “How can a firm be sure that it is accepting the right type of customers?” It’s an excellent question. Many years ago, I coined Baker’s Law: Bad customers drive out good customers, a situation you definitely want to avoid.

It has become common for firms to grade customers and focus attention on the “A” and “B” customers, and even hold out incentives to the “C” customers to upgrade to higher status

Along with your human capital selection, your customer capital criteria are the most important aspect of crafting your firm’s success. The traditional customer grading criteria are most likely familiar to you; they usually include:

  • Amount of annual revenue
  • Prompt payment history
  • Potential for growth
  • Potential for future referrals
  • Actual referrals
  • Profitability of customers
  • Risk of having customer in portfolio
  • Timing of work (fiscal or calendar year)
  • Reasonable expectations
  • Willing to take advice
  • Profitable and not undercapitalized

Certainly, these are important criteria and should be made part of any firm’s pre-qualifying process. Ric Payne, chairman and CEO of Principa, advocates the following 12-point criteria for grading customers:

  1. In business for at least three years.
  2. Pleasant, outgoing personality.
  3. Willing to listen to advice.
  4. Positive disposition.
  5. Technically competent.
  6. Business is profitable.
  7. Business is not chronically undercapitalized.
  8. Business is not dominated by a small number of customers or suppliers.
  9. Clearly established demand for the product or service.
  10. Business has a scope for product or service differentiation through innovative marketing.
  11. Business has scope for improved productivity through innovative management planning and control.
  12. Business has a strategic plan.

These are also good criteria to judge potential new customers, as there is no point in working for, and with people, whom you do not like, or are indifferent about.

When a firm accepts a new customer, it is not merely closing a sale; it is beginning a lifelong relationship. We select our spouses, friends and other important relationships very carefully, so why would we not perform a proper amount of due diligence before selecting a customer? If the customer is worth having, he or she is worth investing some time and resources in, determining if he or she is a good fit for your firm. 

It is no longer wise to accept new customers simply because they have a checkbook and are alive. The most successful firms in the world all have very rigorous pre-qualifying standards, and they do not accept all comers (In fact, they report that they turn away more business than they accept). This is not out of arrogance, but rather, from the recognition that the firm cannot be all things to all people.

It is not possible to value price the wrong customer. Most of the time, the price isn’t wrong; the customer is! The essence of strategy is choosing what not to do. Saying no to a new customer is not necessarily easy, but it is vital if you want to accept only those customers who are pleasant to work with, have interesting work and enhance your firm’s intellectual capital.

Complexity kills a business, and by accepting any customer – especially those that do not fit your purpose, strategy and value proposition – you are adding a layer of bureaucracy that will starve your best customers and put them at risk of going elsewhere.

To manage this inevitable effect, let us now explore the Adaptive Capacity Model.

The Adaptive Capacity Model

Think of your firm as a Boeing 777 airplane, similar to Figure 1 below. When United Airlines places a Boeing 777 in service, it adds a certain capacity to its fleet. However, it goes one step further by dividing up that marginal capacity into five segments (the percentages shown are suggested capacity allocations for a professional firm):

A. First class (5 to 8 percent)

B. Business class (15 to 24 percent)

C. Full fare coach (30 to 50 percent)

D. Coach (15 to 35 percent)

F. Discount/ (10 to 20 percent)

Image Alt Text

Your firm has a theoretical maximum capacity and a theoretical optimal capacity, and it is essential to see how that capacity is being allocated to each customer segment. Your maximum capacity is the total number of customers your firm can adequately service (not how many hours you have), while the optimal capacity is the point where customers can be served at the level of excellence. Usually, for most professional firms, optimal capacity is between 60 and 70 percent of maximum capacity.  

Too many firms will, in fact, add capacity – or reallocate capacity from higher-valued customers – to serve low-valued customers. Furthermore, firms will turn away high-value, last minute work for its best customers because they are operating near maximum capacity and usually at the low end of the value curve for price-sensitive customers. This is common during peak seasons, where high value projects will arise from customers, but the firm is at maximum capacity and cannot handle the marginal work. The lost profit opportunities because of this are incalculable.

Firms worry about running below optimal capacity and cut their prices to attract work, especially in the off-season. This strategy can be risky – you must understand the trade-off you are making. Usually, that capacity could be better utilized selling more valued services to your first class and business class customers. This way, the firm does not degrade its pricing integrity to attract price-sensitive customers.

According to most pricing consultants, one of the leading causes of pricing mistakes is the result of misallocating capacity to low-value customers, due to the fear of not running at maximum capacity.

Remember, the objective of pricing is not to fill the plane; it is to maximize the profit over a given time period. If that can be done at 60 percent capacity, that’s much better, as the excess capacity can be invested elsewhere.

Using the schematic of the Boeing 777 airplane, label each section with the percentage of capacity occupied by First Class (A customers), Business Class (B), Full Fare Coach (C), Coach (D) and Bereavement Fare customers (F). From the above grading criteria, answer these questions:

  • What additional value do our first class and business class customers get from us?
  • How will we allocate and reserve capacity for the firm’s top 20 percent of customers?
  • How much capacity should we reserve in our busy season for our “A” and “B” customers?
  • How much capacity will be allocated to “C,” “D” and “F” customers?
  • Once this “C–F” capacity is full, will we discontinue taking on customers with less than an “A” or “B” grade?
  • Are there opportunities to upgrade our “C–F” customers by offering them more value?
  • Will we conduct a Customer Advisory Board to elicit feedback from our best customers on what we do right, wrong, how they “feel” about working with us and areas for enhanced value creation?
  • Will we establish minimum prices to prevent price-sensitive buyers from boarding our plane?
  • Will we fire customers who are toxic or unprofitable?

Tom Peters is fond of making this point: “It’s axiomatic: You’re as good – or as bad – as the character of your Customer List. In a very real sense, you are your Customer List.”

My VeraSage Institute colleague Tim Williams likes to say that a firm is defined by the customers it doesn’t have. The most successful firms in the world today turn away more customers than they accept because they have a rigorous pre-qualifying process and they understand that, ultimately, bad customers drive out good customers.

There is no justifiable reason for accepting – or retaining – customers that you or your team members personally do not like. Toxic customers can have a negative effect on team member morale, and that will ultimately have a deleterious effect on the firm’s financial results.

If, on the other hand, you work with people you enjoy, not only will you do better work, be a more effective marketer, cross-sell more services and attract like-kind customers, but you will also be a better professional and have a better quality of life.

Indeed, you are your customer list. How does that make you feel?

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