Part 1: Value of a Customer Relationship
Size of Customer
Capsule: The first consideration in customer segmentation is the size of customer. Because a customer gets attention from industry competitors according to the customer’s size, customers of a similar size receive similar treatment from industry suppliers. They tend to buy in similar ways because of this.
Segmentation presumes you have identified all the customers in the market. This may seem laughably simple, but it is not. In a commercial market, a customer may not be a company. A customer is any buying location where that location has the option to purchase from you or from someone else. When you use this definition the number of customers multiplies. You may be selling auto parts to the Toyota Motor Corporation. In order to make those sales, though, you have to call on many locations, each of which has the option to buy either from you or from someone else. The Toyota Motor Corporation is not one customer, but many customers made up of each location that makes a buying decision. This definition becomes important as you consider customer size.
Purchasing Methods of Commercial Customers
The lowest level of the buying decision determines the customer and its size.
A commercial customer may purchase in one of three ways depending on who chooses both the suppliers and the proportions of purchases assigned to each supplier: centralized, standardized or independent.
With centralized purchasing one location, usually the headquarters of the purchaser, determines both the supplier and the amount of the purchase. Each company using centralized purchasing is one customer.
Examples of Centralized Purchasing>>
A company using standardized purchasing has at least two buyers involved in the purchase decision. A central location, usually corporate headquarters, determines an “approved list” of several potential suppliers and may negotiate all prices that the company will pay. The field location is the second buyer in the transaction. Each field location then chooses its suppliers from the “approved list” and assigns the proportions of its purchases each supplier receives. A large standardized purchaser may well receive much attention and the attendant low prices from suppliers. But, the decision about the ultimate sales volume from selling to the standardized purchaser resides entirely in the field locations. The field locations are the customers when a company employs standardized purchasing. It is true that the supplier must also sell to the headquarters location, but this work is simply another cost of serving the purchaser’s field locations.
Examples of Standardized Purchasing>>
Finally, with independent purchasing, the individual customer or buying location makes all decisions about which suppliers to use and in what proportions. Each individual or buying location is a customer. (See Symptom: “Industry customers are forming buying groups.”)
Examples of Independent Purchasing>>
Segmentation starts with the division of the customers in the market into size segments. (See Perspective: “Which Customers Matter Most?“) The most obvious driver of customer worth is the size of the customer. This size largely determines the attention the customer receives from competitors in the market. The larger the customer, the more attention he receives because most suppliers would like to sell large quantities in each of their customer relationships.
Customer Size Segments: Industry Examples>>
You may find it helpful to begin customer size segmentation by identifying four initial customer size segments:
- Very Large Customers buying the first 50% of the market’s volume
- Large Customers buying the next 30% of volume
- Medium Customers buying the next 15% of volume, and
- Small Customers buying the last 5% of market volume.
Very roughly, these purchase volumes are purchased by:
- 7% of the customers (Very Large Customers)
- 13% of the customers (Large Customers)
- 25% of the customers (Medium Customers); and
- 55% of the customers (Small Customers)
So, for example, 7% of the number of customers are Very Large customers. These Very Large customers purchase 50% of total industry sales volume.
This combination of the 50/30/15/5 percentages of the volume of sales and the 7/13/25/55 percentages of number of customers produces the 80-20 Rule. This rule works well when the Company sells to a channel of distribution, an Intermediary customer.
Examples of Intermediary Customers>>
The 80-20 Rule states that the largest 20% of customers account for about 80% of total industry sales.
|Very Large Customers||7%||20%||50%||80%|
Customer Size: Industry Examples »
If the Company’s market were true to that rule, then the Very Large and Large customers, combined, would account for 80% of the market’s total sales volume and about 20% of total industry customers. The 7/13/25/55 is nothing more than a first approximation of the percentages of customers who buy the 50/30/15/5 percentages of total sales.
Once you have identified these break points you may modify them to fit your market. You would check to see that the assignment of each customer to a size grouping really places like with like. When we have conducted this analysis in the past we have, on occasion, added another size category, an Ultra-large customer. This proved useful in industries selling to the likes of Wal-Mart, companies that dwarf their competition.
Sales to Final customers are less concentrated than are sales to Intermediary customers. In consumer and other markets, where the Company itself would sell to the Final customer, the market may be considerably less concentrated. Here, the industry concentration rule might be more like 70-30, where 30% of the customers account for about 70% of total industry sales volume.
The segmentation by current customer size will form the initial segments to examine for an insight into how customers of a size are making their buying decisions today. This is critical information for developing new products and prices for these customers. When you segment the current customers in the marketplace by their size, you make an implicit assumption that these customers will remain in the same size categories they are today. In some markets that is the case and in others it may not be true. (See Symptom: “Medium Sized Customers are Under Pressure from Both Larger and Smaller Peers.”)
In order to project how much volume you might gain from any one of these customer-size relationships, you must also make an estimate of whether a customer in a given size category will remain that size through your planning horizon. Some percentage of the customers in each size category will grow or shrink out of their category during the next few years. If these changes in size category are significant, you would factor them into your estimate of the size of the average customer relationship in each category. You might also examine the causes of these size category changes to determine whether they are predictable today.
This Worksheet, and several other worksheets in the strategy development process, is the result of the questions you will ask customers and the organization of the resulting answers. These questions, and their organization, are subjects of Analysis 2 and Analysis 66. These are very important Analyses for success in your work.
Size of Customer Questions
Customer Size Breakdown
- What are the initial purchasing size breaks for Very Large (50%), Large(30%), Medium(15%), and Small(5%) customer segments?
- For the top three segments (Very Large, Large and Medium), find the minimum annual or other periodic purchase volume that places the customer in this segment. The Small Customer segment includes all customers whose annual or other periodic purchases fall below those of the smallest Medium customer.
- Should these size-breaks change to include customers who originally fell into another size segment?
- What percentage of the total number of customers does each size category represent?
- How consistent are the size categories of customers? Customers may change size categories because they grow or shrink in the marketplace. The Company examines the percentage of customers who began in one category and ended in another and then seeks to understand why those customers changed categories.
Test Your Knowledge: Size of Customer>>
Basic Strategy Guide Users Return To: Step 2
|Summary Points||Next: Role in Customer Relationship|