WORKSHEET #5: Serving Customer Segments on the Size/Role Matrix
This worksheet builds on the previous worksheets, Worksheet #2: Segmenting Customers by Size, Worksheet #3: Defining the Purpose of Roles, Worksheet #4: Creating the Customer Size/Supplier Role Matrix and found in Basic Strategy Guide Steps 2, 3 and 4. Use the information in those worksheets to complete the following three steps and create the Customer Size/Supplier Role Matrix.
To get the size of the average relationship in each size/role segment, divide the total sales in the segment by the total number of customer relationships in that segment. For sales you may use either dollars of sales or units. This calculation gives you the data in the matrix as shown in Analysis 15 and Basic Strategy Guide Step 5.
The profitability of each of these segments is not pictured in this step. You will want to calculate the profitability of each segment, however, in order to assess the segment's attractiveness to you, especially the attractiveness of any customer you do not already serve in the segment. To estimate this profitability, follow these steps:
Calculate the average price paid by the customers in each segment. This calculation is based on our own company's experience. To get this number, we place our own customer relationships into the matrix. We, then, calculate the average price our customers pay in each Size/Role segment and assume that the average unknown customer in each size role segment pays the same price as the average price we receive in the segment.
Estimate our cost to serve the average customer in each segment. This calculation would assume the average sales volume in the segment. The cost accuracy depends on the sophistication of our customer cost system. If the cost system is not good at the individual customer level, you might consider using a gross margin figure which subtracts the cost of manufacturing from the revenues realized at the average price, and then making a rough estimate of the company's other costs-to-serve the average customer in each segment.
Subtract the cost-to-serve the average customer in a segment from the revenue the customer generates using the average volume in each segment to get the average profitability by segment on the Size/Role matrix.
The average growth rate in each segment is not pictured in this step. This growth rate, though, would be of help to you if you want to calculate the net present value of the average relationship in each segment. There is a complication in this calculation. Customers sometimes change size segments. For example, a customer who is a Very Large customer three years ago may have failed to keep up with the market and become a Large customer today. On the other hand, a Medium customer three years ago may have grown in to a Large customer today by gaining share in the marketplace. The calculations below may help you adjust for this problem:
Pick a date three to five years before today and develop the size/role matrix for the 100 customers as those customers were at that earlier date. Let's assume, for the moment, that is three years ago. Calculate the sales by Size/Role segment three years ago for all customers in the sample.
Define the segments by the sales that existed three years ago. For example, if a company was a Large customer three years ago but had become Very Large today, classify the company as a Large customer.
Using the sales by Size/Role segment for those customers three years ago, find the total sales for the customers in each Size/Role segment three years ago and the total sales of those same customers today. Note that your number of customers in each Size/Role segment may be different than the number in the current Size/Role segment sample.
Calculate the compound annual growth rate for the total sales by Size/Role segment, with three years ago as the initial date and today as the end date.
Use this growth rate as part of the calculation to estimate the net present value of the average unknown customer relationship in the market today. This approach assumes that growth rates in the future will be the same as in the past. You may wish to modify this assumption if your view of the future is different than that of the past.
If you wish to calculate the net present value of an unknown customer relationship in any of the Size/Role segments, you need one other piece of information, which is the life of the relationship. If you choose to do a net present value calculation, then your analyses of each of the 100 customers should include an estimate of how long the customer has been in each of his supplier role relationships. If your sales and marketing staff do not know the answer to this question, then include that question among those that you use with the customers you interview in detail.