What will losing a major customer cost?
“What’s happening on the inside of a company is being felt on the outside by the customer.”
In July, CEO Sigma Healthcare Mark Hooper announced losing a contract worth $1.7 Billion and in the next financial year earnings would half to $50 Million. Sigma distribute products to 400 stores for My Chemist and Chemist Warehouse and could not negotiate a new contract with their biggest customer.
What does this mean for Sigma? Sigma says “It's working to cut costs, but that won't offset the lost revenue from the contract.” From a financial perspective Mark Hooper made a rational decision:
“If we had signed a new contract on the terms required, we would have been announcing halving of our EBIT with the $300 million of capital still tied up. So while it wasn’t the objective of the exercise, we felt on balance if we couldn’t generate any rate of return from the business, we were better to have the $300 million capital back.
We have been consistent all the way through, that unless we could generate acceptable level of returns for Sigma shareholders, then we wouldn’t enter into a new contract. And as I say, I just can’t imagine anyone would applaud a decision where we announced we had a new contract, and we’d halved our earnings in the process.”
Consequences of losing their biggest customer.
Apart from the financial consequences above, Sigma needs to focus on getting cost out of their business. And in every business, this is easy to promise and hard to deliver, and Mark knows this:
“There’s fixed costs that Chemist Warehouse absorbed that we will start working on trying to remove. We won’t get all those out, but we believe there’s a reasonable proportion we can remove.”
For at least 18 months, Sigma will have to focus on the internal issues of getting significant cost out of their business. Anyone who has worked in a business going through this knows it is tough to keep your employees motivated. Also, it’s tough to keep them focused on their existing customers when they keep looking over their shoulder to see if they will be next to lose their job.
What are the chances of this happening to you?
Most managers read this and say to themselves, if we lost a major customer then the consequences would be serious and similar for us too. But, there’s not much chance.
“I’ve been through three negotiations with those guys where quite often they go to the edge, you still find a way to do a deal. And I thought that was probably the way this one was likely to pay out. But they have, obviously, been given a very, very sharp deal.”
So, Mark Hooper thought there was not much chance too.
How can you reduce the chances of this happening to you?
Two actions can help reduce the chances of this happening to you. One is how you manage your biggest account and the second is how you manage your portfolio of accounts.
First manage your biggest account strategically. Leaving aside the details of how to manage accounts strategically, you must focus on increasing their business results. In the example, Sigma needed to find ways to help Chemist Warehouse to increase sales, to reduce costs, to increase profits or to increase return on investment. Not just during contract renewal but while operating the contract.
Then, during contract renewal discussions, the conversation is not just about delivery performance and cost of service. Discussions include value delivered to Chemist Warehouse beyond the requirements of the current contract: Sigma’s contributions to improving the business results of Chemist Warehouse.
Second, stop thinking only about your biggest account. Manage your portfolio of accounts strategically. Try this: create a chart with Annual Growth % plotted against Annual Sales $Millions. Then plot a line on the annual growth axis showing market growth. Next plot a line on the sales axes showing a revenue that separates Large accounts from Small accounts.
This gives you a chart with all of your customers in one of four quadrants.
If Sigma had done this exercise, then Chemist Warehouse would be in quadrant 2: a Large account growing faster than the market. Probably in the top right-hand corner, well away from other customers.
What’s wrong with this? Well imagine the account is only 10% of your sales, but it is growing at 30% more than the market rate. Surely you should take the orders and let your revenue skyrocket too? Well if that’s all you do, then in 5 years the same account could be 30% of your business. That’s fine until they come to you and say: to keep our business we want a 15% reduction in prices. Now, what do you do? Discount the price or lose 30% of your business.
““Before you can break out of prison, you have to realise you are locked up.””
So what can you do? You take the business from the fast-growing account. And you work extremely hard to find accounts you can help grow faster than the market, preferably in different segments to the fast-growing account. Why? To prevent the fast growth account becoming as much as 30% of your business in 5 years. To prevent you from getting addicted to their growth.
“I’m not telling you it is going to be easy, I’m telling you it’s going to be worth it.”
This is much harder work than simply taking orders from the fast-growing accounts like Chemist Warehouse. But without doing this hard work of helping other accounts then you are at risk of being held to ransom by your biggest customer. And at serious risk of becoming addicted to their growth.
Manage your risks by managing your best customers strategically. Focus on growth while you still can.