Can You Identify Your Best Customers?

This question has been on my mind since the untimely passing of Tony Hsieh at the age of 46. Most famous for helming shoe retailer Zappos for nearly 20 years, Hsieh was an inspirational advocate of putting the customer at the center of a company’s worldview.

Zappos encouraged its customers to buy many shoes and return nearly as many; despite being very costly logistically, such service was understood as critical to helping customers become comfortable with shopping for such fitting-dependent items online. Famously, customer service was also encouraged to go to whatever lengths were required to assist customers, even if that meant much lower call volumes (the metric by which many customer service teams are graded).

This indefatigable concentration on his customers made Zappos philosophically a natural pairing with Amazon, which purchased the shoe retailer in 2009 but left it to operate relatively independently. Hsieh retired only this past August.

Alfred Lin, Zappos’s former CFO, COO, and Chairman, made an observation about the company’s customer centricity that caught my eye:

Lavish customer service was costly in the short run but paid off long term, Mr. Lin said. Those who returned the most shoes also ended up paying for lots of shoes and were the most profitable customers, Mr. Lin said.

This brings us back to the opening question: can you identify your best customers?

It sounds like a simple question. You may think, “of course we know who our best customers are!” But what actually constitutes a good customer? Can you articulate it?

The danger I see is illustrated by Lin’s quote. The very customers who by one metric (returns) would appear to be the worst were actually the most profitable. Conversely, customers that may appear to be your best may actually be hurting your company. How can we tease this out?

Best Customers Appearing as Worst

Sometimes, our best customers may be obscured from us or even made to appear as our worst. This can be the case when analysis is done in a siloed manner, blind to the strategic context in which customers interact with the company. Boilerplate analysis can lead to silos, because a metric that is relevant to one company may not be to another.

Customer behaviors must be understood holistically and in the right strategic context. Some companies may choose to focus on reducing customer returns. However, a company in Zappos’s shoes (forgive the pun) that focused on reducing returns would have scuttled their best customer relationships.

Companies should seek long-term profitability from their customers. Metrics for determining good customers must share this long-term vision, or else analysis and strategy will be at loggerheads

Putting too much weight on a single metric out of context is dangerous. Is your analysis equipped to see context?

Worst Customers Appearing as Best

The mirror case of the above is misidentifying a bad customer as a good one.

We’ve seen situations where customers that looked stellar based on sales revenue actually lowered the company’s profitability once we looked at the bottom line. This speaks to the importance of looking at the entire price waterfall and commercial policy to determine how much of that sales revenue becomes pocket revenue, that is, the amount of revenue in your company’s pocket after considering all discounts and rebates.

Even that isn’t the full story, of course. Sales commissions and product costs must factor into the overall picture of profitability. Sales incentives that reward volume or revenue can have the disastrous effect of paying your salespeople to give away product for free.

Only the Best Customers

Your best customers are those aligned with long-term profitability, as well as your strategic company goals. They recognize your differential value, the ways in which you solve their problems better than the competition. They also help you to find and acquire other good customers.

Zappos recognized this. By providing lavish customer service, it could reassure shoppers and acclimate them to its business model. Customers learned that, even with shipping times, the ease of buying from Zappos made it a winning solution compared to in-person shopping. And they told their friends.

We should all take note. Rest in peace, Mr. Hsieh.