Terminating toxic customers: enhancing firm profits through customer cultivation.

You know it when you feel it. The customer on the other end of the phone is simply toxic. Nothing is right with the relationship. Not their projects. Not their respect for your services. Not their attitude toward your team members. Not your level of service. Payments are late and invoices are frequently challenged. Their projects are the last to be started and they are finished late. You simply regret the day they walked into your office. You know that you should be professional and terminate the relationship.

Poor customer fit is extremely damaging to your firm. So much so that my colleague, Ron Baker, created Baker's Law: Bad customers drive out good customers, as a corollary to Gresham's Law: Bad money drives out good money. And as professionals, we have this conundrum: We are considered leading business advisers, yet we continue to allow bad customers to almost freely inhabit our firms. They zap our energy and increase the risk of ill financial health for the firm.

Ask a CPA firm partner about his customer misfits and he can name them and why they aren't right for the firm. Ask these same partners why they retain these customers, and they say they don't want to lose the revenue.

Firing customers is difficult. Firms invest intellectual and financial capital into establishing each customer relationship. Additionally, traditional partnership compensation models create barriers to terminating customer misfits via financial punishment for lower billings. Other entanglements, including anger from related referral sources, marketplace opinion, fear of decreased earnings, fear of related customer revolts and fear that they will be judged a failure are just a few of the many barriers to initiating termination procedures.

THE FIXED CAPACITY DILEMMA

Professional service firms have fixed capacities to serve customers in the short, medium and long term. Unless a firm outsources 100 percent of its projects, it is constrained by its ability to produce work from a fixed quantity of in house producers.

This fixed capacity to serve is generated by each profession's necessary lead time to train, educate, develop and immerse team members to the degree necessary where they can perform, supervise and manage projects and relationships.

Professional service firms are like airlines: they are heavily invested in fixed capacity (and fixed costs), with a pre-determined configuration (e.g. firm talents and capabilities are known and fixed). Customers of CPA firms, then, are comparable to airline customers. There are diverse reasons for customers to "fly" with their chosen firm. Some fly with a firm out of convenience, while others fly out of necessity. And like airline customers, not all firm customers are created equal.

Some are willing to pay a premium and demand a corresponding high level of service, while others are willing to forgo luxuries and voluntarily accept a lower level of service and fly in the back of the plane. Still others prefer somewhere in the middle.

Firm leaders must properly identify the differing service levels desired by customers and confirm the following:

* The firm's pricing structure is adaptive enough to capture pricing opportunities for differing levels of timing and service.

* The firm's capacity allocation is consistent with its customer demand curve.

* The firm's customers are consistent with capacity allocations.

* The firm isn't inadvertently "upgrading" customers from a lower level of service to a higher level without a consummate change in price and education of the customer.

* The firm is retaining ample capacity to handle last-minute "flyers"--important customers that are willing and able to pay a premium price for a last-minute project.

IDENTIFYING MISFITS

Several methods can identify what I call "back of the plane" customers--those who you shouldn't be servicing but are because you haven't determined how to show them the emergency exit.

My candor may seem callous, but the health, vitality and morale of your firm is on the line and that is more important.

Here's a process to evaluate and classify your customers:

* Ask each team member of your firm to identify up to two customers they would get rid of. Their decision is absolute. The partner is responsible for the termination within one business cycle. Note that not only will the team help partners with the tough identification issues, the firm benefits doubly because the partners reinforce to the team that they really do value their opinions and place them ahead of any short-term financial matters. Additionally, team members highlight, in advance, problem customers, which helps firms avoid forced customer terminations.

* Each firm member rates each customer to identify the level of customer compatibility on two levels. Level one is on their personality--how well do you like this customer. Level two is on their work--how well do you like their work. Low scores generally mean you shouldn't be working for them.

* Review your customer's financial credibility and measure how well they maintain their financial commitments with your firm. Basically, how timely do they pay?

* Categorize your customers by type of work, industry, timing of work, anticipated estimated firm capacity allocations, level of partner involvement required and future growth potential.

* Investigate the level and types of team resources that should be used to service the customer. In other words, can you alter the service team, freeing up impacted team members, and substitute replacements with minimal interruptions to service quality, timing and pricing.

Like a farmer that rotates crops to increase yields and reinvigorate the soil, CPA firms must also forcefully churn its less valuable customers to free valuable resources and capacity for new projects and new customers.

EMERGENCY EXIT PROCEDURES

For most professionals, admitting that they have "back of the plane" customers is relatively easy. Identifying the leading candidates to be released to the competition is slightly more painful, but fairly straightforward. Once they are identified, the hard work begins. But without follow through, the previous exercises of recognition and identification are wasted efforts.

There is no easy way to fire a customer. Even when you really don't like them, and when they have work you detest, it is difficult to terminate a relationship. The psychological aspects and emotional pain cannot be downplayed. Such feelings are very real and firms must develop methodologies to handle them or success will be limited.

Once the decision is made to get rid of a customer, the following alternatives exist:

* Internal Transfer. When a customer doesn't fit with its current partner or team, yet is deemed salvageable as a profitable customer, the firm can perform what I term an "internal firing." Here, the partner, team or department responsible for servicing the customer is changed to better fit the customer with the firm. This simple method is beneficial when a customer's needs have changed and new blood with new ideas about services and pricing can instill new life into a sagging relationship.

* Bundle and Sale. Many firms have bundled groups of customers and sold them to other firms. This process provides both cash for the customer goodwill and is best used when a firm changes strategic direction and there are a number of customers affected.

* Direct Termination. This can be done by letter or in person. If you write a letter, simply state that your firm believes the customer would be better suited being serviced by another firm. You could even include business cards of firms that you believe could better help the customer.

If you do this in person, schedule a meeting with the customer to discuss the account. Let them know that you value their relationship more than their revenue and that you believe they would be better serviced by another firm. You can also indicate that you have an ethical obligation to see that they receive the best professional services available and that you believe another firm would be better than yours for the services they need.

These termination options are not an exclusive listing, but they are the most common. I do not suggest that you raise your prices in the hopes that clients will leave voluntarily. Ask any firm that has tried this method and you will learn that these back of the plane customers don't leave. Once you have raised their price, the economic and psychological aspects of these misfits for your firm are exacerbated. They stay because they aren't price sensitive, so raising prices increases revenue, but does not change the customer base.

PREVENTING THE ILLNESS

Although terminating the poor performers requires each firm to create its own customer selection and retention process, highly successful firms minimize the probability of admitting poor performers. Paraphrasing Herb Kelleher, noted former CEO of Southwest Airlines, first let's not pollute our river at the source.

The best way to avoid toxic customer relationships is to not accept them. It is far superior to be overtly discriminating (nothing illegal, of course) about who you'll work with and what type of projects you'll work on. As David Maister advises, a true professional only works on projects they like for people they like. Accepting anything less is simply unprofessional. You must be prepared to identify what works and what doesn't. The most successful firms continuously turn away more work then they accept. They are extremely picky--and extremely profitable.

My firm requires prospective customers to complete a questionnaire prior to our initial meeting. The questionnaire helps us identify what services are being requested, their budget, their level of sophistication, their expectations of us and how aggressive with "tax avoidance" opportunities they are, along with information about where they were born and raised, colleges attended and other soft information.

The questionnaire first weeds out people who aren't really serious (e.g. customers looking for the cheap fares), who are unwilling to open up to their adviser or who are merely using a quote as a bargaining chip against their current CPA. Second, it saves time and resources. Their answers are part of their permanent file that all team members have access to. Third, it provides a starting point with pricing. And fourth, asking these types of questions demonstrates that you value your services and resources and that you take a prospect's needs and wants very seriously--by investing early to learn who they are and how they think.

Learning customer expectations at the beginning of the relationship is the best method to avoid the pain of customer divorce.

RETURN TO THE BEGINNING

Firms that make managing their customer list a core competency set the stage for achieving long-term success. Not just financial success, but psychological and emotional success. Working with bad customers harms firm morale and leads to poor customer service. Customers that terminate firms for poor service will report their experience to their friends and colleagues. Customers that are terminated, professionally and with care, may not be happy at the time, but the long-term effects are generally positive.

The time is now for firms of all sizes to perform their customer quality examination and take appropriate action. Failure to act now only harms the firm and its customers. Appropriately handling customer misfits helps the firm succeed--now and in the future.

Daniel D. Morris, CPA, is co-founder of the VeraSage Institute, a think tank dedicated to promulgating the benefits of value pricing, improving customer service and human capital development. You can reach him at [e-mail].