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The cost-to-serve (CTS) your patient-customers

Once you transact a good or service with your patient-customer, you may be inclined to think you’re job is done. Nope. You’ve got to maintain that customer and the offering they purchased. Let’s talk CTS.

Healthcare entrepreneurs often think the hardest part of a business is getting the sale (of a good or service). No doubt it is. Convincing a customer/client to purchase your offering at a profit-, revenue-, or sales-maximizing price is challenging and noteworthy (when you succeed) (see menu above). However, your job isn’t done. Besides customer retention and repeat business, you’ll have to maintain your existing customer base - those who have made a purchase. And that’s where your cost-to-servce (CTS) comes in.

Our case

Let’s use a case to understand CTS.

This case is an extreme and, unfortunately, common example of an imbalance in your cost-to-serve. It’ll provide a great foundation for our examination.

How do you articulate to your clients and contacts that you are off duty for a week and that you will handle their requests when you return. This week has been one of the most intruded upon weeks of vacation I’ve ever taken. Everyone seems shocked that I would be off. It’s one of two weeks off I take each year. I really don’t know how I could do more than I do, and retain sanity.

What is the cost-to-serve?

The cost of providing a service or good to your customer isn’t simply the inventory cost or the opportunity cost. There’s a lot of work that goes into making the sale (transaction) and maintaining the sale (post-transaction). As you might imagine from our example above, once you’ve gained a customer/client, you need to provide them with additional services to ensure that their experience is as good as it can be. Things like a help center, troubleshooting, same-day appointments, seasonal appointments, and/or email responsiveness, all help a customer enjoy that which you’ve provided to them and make them want to return. Some of these factors are pertinent to our case.

Analyzing the cost-to-serve

Our analysis begins with a simple profit ∏ calculation at the customer level. Over a fixed period of time, determine the profit that you earn from each customer you have. A customer-specific profit table will begin your analysis.

Customer-level π | Note that some customers result in a loss | These values were generated using random number generation and are representative of a new venture business.

We have twenty (20) new customers in our business. And even though our venture is making a profit of + $1657.00, there are customers that are losses. The customers that result in a negative profit need to be analyzed further.

Customer profitability analysis

Once you’ve got your customer-level π data, you can construct a Customer Profitability Chart. Charts like these reveal how much of your customer base help or hurt your profits.

Customer profitability analysis | Green line = 100% profits | Black = profit-making customers | Red = profit-eroding customers

The chart shows you the percentage of your customers (x-axis) that contribute to a specified percentage of your business’ profit (y-axis). Notice that 20% of your customers generate ≧80% of your profits - the classic Pareto 20/80 rule.

About 65% of your customer base generates a profit (black line). Subsequent customers begin to lower your profit margin. About 35% of your customers are contributing to profit erosion (red line). These are the customers that need your attention.

Profit-eroding customers → high cost-to-serve

High cost-to-serve customers generally cause profit erosion. These customers use a lot of your venture’s resources. For example, they may

place unusual order quantities, making it difficult to manufacture your products efficiently,
not take inventory in a timely manner, increasing your holding costs,
demand after-hours, weekend, vacation, and/or holiday service (as in our case),
not pay in a timely manner, increasing your accounts receivables, cash-to-cash cycle, and working capital requirements, (an increase in any or all three places a economic strain on your venture),
return goods for refunds often, or
more.

Any or all of these *eccentricities* add to the cost you must bear to service these particular customers. You may not be passing on these costs to those customers, which is probably why they are eroding your profits.

Analyzing a high cost-to-serve customer

The most nuclear option is to disconnect from a high CTS customer. As healthcare providers, we’re not keen on, accustomed, or allowed to easily disconnect from our patient-customers. In business, however, disconnecting can be done far easier - the ease of which is exactly why you shouldn’t take this step without further analysis.

The opportunity cost of removing an existing customer is high. Securing a new customer to take their place is hard and costly, especially if the customer you removed is a high-volume one. The next analysis to perform is the volume demanded by your profit-eroding customers.

Customer profitability analysis and quantity demanded (blue bars) | Quantity demanded was generated by random numbers and is representative of a venture startup.

Dismissing a high cost-to-serve customer

Profit-eroding customers that are high-volume customers are difficult to replace. If you readily dismiss them, you’ll be left with two big challenges:

finding a similarly high-volume customer, and/or
bearing excess capacity costs while you find another high-volume customer

Overlaying the customer profitability analysis (above) is the quantity demanded (volume) data (blue bars). Let’s look at the 5% of customers (x-axis) that cause your profit to drop from 158% to 148% (y-axis, red line). These customers provide 7% of your total units (e.g., hours of service) ordered (blue bars: 85%-78% = 7%). If you eliminate these customers, you’ll have a 7% excess in capacity.

5% of your customers order 7% of the total service time you provide & cause you to lose 10% of your π.

In our example, that 7% excess in capacity could be useful to take an uninterrupted vacation or allow you to have a regular slowdown during the summer months. You may be willing to disconnect from these customers so you can **retain your sanity** (see case above).

High volume customers

Keep in mind, that the median customer in your business demands 4.06% (IQR 2.66 - 8.02%) of the service you provide. The one customer demanding 7% of total units offered is on the high end of your business. While you have six (6) other customers that demand the same or more service from your business, you may not want to lose this one high cost-to-serve customer.

Histogram of units demanded (x-axis) | Median units demanded is 4.06% of the total units demanded across all customers (IQR 2.66 - 8.02%).

Convert your high cost-to-serve customers to lower cost-to-serve ones

Easier written than done. In order to make this conversion, you’ve got to align your needs for lower cost with their needs of a higher/better amount/type of service. The most straightforward way is to charge for the *features* of the business that are being used in excess by your profit-eroding customers.
In our example, assessing a special cost for calls/emails that occur during a pre-specified time period or emails that require a 24-hour turnaround time for a response would be a solution. Be transparent with your customer - let them know that these additional features, while not critical for the success of the service you are providing (your core business), are available for a price outside of the core offering price. Your profit-eroding customers can then choose to avail themselves of these *add-on* services, or not.

There you have it. A quantitative manner by which you can identify high cost-to-serve customers and some ideas on how to transition them to a low cost-to-serve environment. Leave your comments/questions below and I’d be happy to answer them.

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