42 Degrees - Business from a different angle

Many companies are persistently swindled, wrongly accused or exploited by a minority of customers hell-bent on abusing their trust and good will.

A well-known high street chain has long operated a 'no questions asked' exchange policy for clothes. If you buy something and, for whatever reason, you don’t like it, you can return the item unused. This saintly organisation will exchange it or give you a refund on the spot. It’s a policy that has helped to turn it into a much loved and trusted national institution.

This company acts as if its customers are always right. And yet over the decades it has found that a small but persistent minority abuse this trust. For instance, a surprising number of women – and it is mostly women – buy an item (a dress, skirt, blouse, even underwear), wear it once and then return it.

If staff members suspect the customer is pulling a fast one, the high street giant has trained them to retire behind a screen to administer a foolproof molecular analysis on the item – otherwise known as 'sniffing it'. If it has been worn, staff politely decline the exchange.

The phrase 'the customer is always right' was coined by Victorian retail magnate H. Gordon Selfridge, founder of London department store Selfridges, in order to promote a service ethic in his store. It wasn’t so much a comment on their morality but the fact that they held the whip-hand in commercial transactions, so you had better be polite when dealing with them.

However, as our high street retailer has disovered, customer behaviour suggests that, far from always being right, customers are occasionally a little incorrect, often mistaken and sometimes just plain wrong. "Even though it makes perfect sense to act as if the customer is always right, and you must respect your customers, the reality is that it is just not always true," observes Merlin Stone, visiting professor in customer relationship management at Cranfield School of Management.

'Not being right' can cover a multitude of sins and behaviours. Having analysed years of sales complaints data from large corporations, Professor Stone concludes that between five and ten per cent of customers are prepared to engage in activity that is just plain illegal.

Fraud and theft are relatively clear-cut issues to deal with. But outright dishonesty is only one of the ways in which customers are sometimes wrong. "Failure to recognise this basic truth can have enormous and costly repercussions for your businesses," warns Professor Stone.

Take the development of new products and market research. Obviously it makes sense to seek customers' guidance. After all, they are best placed to know what they want and where, when and how they want it. Maybe. If the new product is a slight improvement or variation on existing goods, consumers are quite accurate at predicting how, when and where they might use it.

If, however, the new product is very different to what already exists, then people are notoriously poor at predicting their own behaviour. As Simon Woodroffe says in our Big Interview, "If I'd researched the concept of people sitting on the floor or lying on beds drinking beer from taps or eating sushi off a conveyor belt, it would never have happened."

There is an even more important way that customer mistakes cost your company dear and that is in the area of customer service. Despite putting huge effort into explaining its products, one US-owned hi tech company could not understand why its service lines were so busy. "Analysis showed that nearly half of all calls were based on customer error. Customers were not right, they were mistaken," says Professor Stone. "They had failed to read the rules and play by them."

But the big one, the area in which customers can be very, very wrong, is in their profitability. Obviously, you make more money out of some customers than others. The trouble is that most businesses actually lose money on some customers, which means they might be better off without them.

"Typically, if you were to rank your customers in order of profitability, each tenth of customers is half as profitable as the last," says Richard Dixon, director of customer relationship management firm Black Sun. "So 80 per cent are profitable, but decreasingly so. Ten per cent you break even with and ten per cent are unprofitable."

There is no single reason why some customers are more profitable than others. "Some need more educating in how to use your product. Some drive harder bargains. Others are simply more promiscuous and have a wider repertoire of suppliers, so the volume of business they give you is lower and the costs of doing business with them are spread over fewer transactions," says Dixon.

Sometimes even apparently good customers turn out to be bad. For instance, a stock broking firm recently found that a customer with a multimillion-pound share portfolio was tying up three financial advisers almost full-time with requests for help and information.

In reality, of course, it is hard to track the precise profitability of any customer. However, even relatively unsophisticated businesses can do it providing they understand two key concepts: lifetime value and cost to serve.

"It is also not wise to assess new customers solely on the value of their first transaction, as their initial purchase may not be typical, and because of costs to acquire. A more useful approach is to work out how much you make over the length of your relationship," says Dixon. Simply multiply the average revenue from each sale by the number of sales you expect on average from your customers.

Cost to serve is harder to assess, even for big business, but looking at simple measures, such as how long they take to pay, the amount of post-sales service and extras they haggle over, should give you a good idea. "Just look at the costs that vary by customer (as opposed to fixed costs). You don't have to get too scientific about it," says Dixon.

Subtract costs from lifetime value and you have a clear idea of which customers are right (for you) and which aren't. How you handle this information however, is another matter. To find out more read Part 2: When the customer gets it wrong.