“The number of new-vehicle buyers who owe more on their trade than it is worth — the classic ‘upside-down’ scenario — has increased substantially over the past years. While only 25% of trades were an upside-down situation in 2001, today 38% of trades are in this category.” [1]

Activity Based Costing (ABC) is exposing a similar trend among distributors and manufacturers. ABC commonly finds 20% of customers result in 80% or more of profit. Therefore, the remaining 80% of customers are upside-down for the seller… they’re significantly unprofitable.

What is an upside-down customer?

• Upside-down customers result in a net loss to the P&L bottom line.
• Upside-down customers consume overhead activities in excess of gross margin.
• Upside-down customers, in other words, owe the supplier more than they’ve been billed.

How are unprofitable, upside-down customers created? Similar to upside-down car loans, it takes two to tango … a customer with significant wants served by an enabling supplier. Activity Based Costing identifies upside-down customers. To get all customers right-side up… profitable… distributors and manufacturers need to implement one or more of the following changes:

Ten Steps to Get Upside-Down Customers Profitable

• Stop paying sales commissions on upside-down customers. Paying commissions on all sales revenue is simple but too simplistic. Use ABC each quarter to identify which customers have a pre-tax profit. Pay sales commissions on only profitable customers. This gets sales reps interested in sales and profits.
• Use Activity Based Costing to define a minimum-order policy.Enforce the policy to eliminate upside-down sales transactions.
• Use ICMS’ new CostMapper™ softwareto flowchart and cost cross-functional activities. Use the process map to elicit improvement ideas from employees and customers. Reducing the number of activity handoffs between departments improves quality and cost. For a free demo of CostMapper™, go to ICMS.net.
• Significantly reduce or curtail sales rep onsite visits to upside-down customers.As a result, you may find that you’ve got too many sales reps.
• Increase prices on upside-down customers. They will complain but will likely keep buying from you because they like your products, people and processes.
• Use UPS, FedEx Ground, a local courier or drop ships to deliver small quantities or inexpensive products.Many companies using ABC discover that outsourcing deliveries is lower cost, leading to a reduction in delivery trucks and headcount.
• Offer upside-down customers an incentive to pick-up their order. The savings can turn a customer’s profit right-side up. ABC is the best method to calculate the savings you can offer.
• Use Nextel or a similar cell phone service as an inexpensive GPS system.For example, many home care companies are successfully using Nextel to more effectively dispatch trucks and drivers to customer homes.
• Outsource activities that have significant excess capacity.For example, if your accounting staff is idle 50% of the month, reduce headcount and use an outside CPA.
• To make sure customers pay for the activities they consume, separate the cost of the product from the cost of the activities.Made popular by healthcare distributor Owens & Minor, menu-based pricing invoices customers for the activities they want and consume (e.g. Make Delivery, Change Order, Expedite Delivery, Late Payment).

In his new book “Why Great Leaders don’t take Yes for an Answer”, author Michael Roberto’s research found that profitable organizations have a habit of surrounding their senior management team with talented staff empowered to say “no” at the appropriate time. Organizations that say “yes” most of the time end up with a large group of upside-down, unprofitable customers.

If you suspect your organization have upside-down customers, implement Activity Based Costing and just say “no more”.

[1] “Number of ‘Upside-Down Vehicles Buyers is Increasing Substantially”, J. D. Power and Associates, The Auto Channel, March 25, 2005