The Cost of Dropping Your Most Demanding Customers

When margin misses plan, executive teams tend to start the review with the accounts that consume the most engineering and service time. Those hours are visible, and every one of them is charged to a named customer, so on a customer-level P&L they look like cost. Cutting the hours improves that account's economics on paper.

Two things are wrong with that move. The savings is smaller than it looks, and the company was getting something for that spending that never appears on the cost line.

The cut that does not move margin

R&D and engineering are visible line items on an income statement, and against the total cost structure they are small. In the auto industry, for example, designing a car costs a fraction of what the company spends building that model for a year. Yet the choices made during design determine most of that cost.

Margin depends on pricing far more than on engineering spend. Keeping costs down matters too, but running lean, buying well, and staffing to demand are the minimum for being in the market. Every serious competitor is working on all three, so a company gains no edge from them.

That is why a company almost never needs to take engineering spend out. Cutting it saves little and leaves pricing where it was, so margin barely moves. Cutting it can also be devastating to the programs that will drive revenue and earnings in the years ahead, which means it helps in the short term and hurts in the long term.

What a demanding customer gives a supplier

A customer that puts heavy demand on engineering and service resources is usually trying to solve a problem. Customers that lead their markets offer a supplier more than a workload. They bring the supplier into how they see the market and where they think it is going. They hand over an unsolved problem, and the solution the supplier develops with them may apply well beyond that account.

The cost line does not record that benefit. The hours are charged to one customer, but the solution built in those hours may serve the whole market.

Deciding where to compete means knowing where a market's profit is now and where it will be later. Financial data shows where it is now. Financial reports cannot show where the profit will be next, and a customer working on unsolved problems in its own market is one of the few sources of that answer.

For more on how a company maps where profit is now and where it will be next, see Where the Profit Actually Lives.

The demanding accounts to keep

Not every demanding account justifies that engineering time. The ones that do meet three conditions:

• A culture of asking for new solutions rather than lower prices on the existing one.
• The capital to fund what they are asking for.
• An understanding that this is a partnership, which means they let the supplier inside the problem instead of handing over a specification.

Where those three are present, the customer has a market position behind its demands and funds the work because the solution improves its own operating profit.

Where they are absent, the demands are just as heavy, but the customer brings no market insight with them. The customer has already worked out the answer, so the supplier's engineers provide only capacity, and what they build has no use beyond that account.

A company that drops demanding customers without making that distinction loses the accounts that showed it where the market was going.

The question to ask before the cut

Analysts running a cost review will find the engineering and service hours quickly, because they are easy to attribute. The long-term benefit of those hours is much harder to identify.

Before anyone cuts those hours, the executive team has to know which customers use them and whether those customers are leading their markets or following.