Academic journal article The McKinsey Quarterly

Think Small, Win Big

Academic journal article The McKinsey Quarterly

Think Small, Win Big

Article excerpt

Companies often treat small businesses as a single segment

What's needed is better insight into which customers you can serve most profitably

Technology and alliances can play a big role

Businesses with fewer than 100 employees account for 98 percent of all companies in the United States, roughly two-thirds of the country's jobs, and one-third of its gross national product. They also make up a significant part of the action in many industries: half of the turnover in the travel industry, for example, and one-third in the telecommunications industry, worth $80 billion and $57 billion, respectively.

In other words, small business is big business - above all, because small companies can often be targeted, profitably served, and retained without the discounting that large corporations demand. A transportation company found that its biggest accounts were earning a sorry 2 percent before taxes, as opposed to 10 percent for a standard small account. The disparity was explained chiefly by the high level of discounts offered to large customers (an average of 18 percent for "strategic" companies) as against 1 percent for their smaller counterparts. The better pricing structure more than offset the higher cost of serving small customers.

Merrill Lynch realized the potential of small (and medium-sized) businesses in the early 1980s, when it created a division to focus on their needs. Other companies too are realizing that serving this market effectively is essential now that aggressive growth and revenue goals are intensifying the competition for the largest customers. Ameritech, Federal Express, Wells Fargo, KeyCorp, and Dell are among the businesses that have increased their revenues and profits alike by finding ways to target, attract, and retain small customers.

Why, then, don't more companies join the party?

The problem

Serving small businesses poses three hard-to-manage challenges: identifying your profitable customers, acquiring new customers cost-effectively, and reducing what you spend to serve them.

It is hard to identify profitable small customers because these businesses are so diverse. Indeed, there are millions of them, and many defy straightforward classification into distinct, actionable segments. Traditional demographic segmentation by size or industry rarely helps.

Acquiring small customers cost-effectively is tough, as well, because lower volumes per customer rule out the one-to-one sales model typical for large customers. (Direct sales costs, which can be as low as 0.05 percent of sales for the latter, can run above 5 percent for the former.) At the same time, the sales process may be no less complex for small than for large businesses, because small ones do not have sophisticated purchasing departments.

Finally, keeping down the cost of service is difficult, since besides lacking the purchasing expertise of large companies, small ones may not be able to afford an internal support infrastructure and thus look elsewhere in the value chain for missing expertise, from postsales computer support to financial advice for loans. Many products, such as computer servers and PCs, are "mission critical" for small businesses in a way they almost never are for individual consumers. This increases pressures - but not revenues - exponentially.

Yet companies catering to these small clients cannot afford to let up on service, because they have a higher "churn" rate than larger clients do. Perhaps 5 percent of a company's largest customers might turn over in a given year - but more than 20 percent of its smaller customers. For one thing, smaller businesses have a relatively high failure rate; about 20 percent of them go out of business in the first year. Second, small businesses have more choices than they did in the past as more companies wake up to the opportunity of serving them. In 1984, when AT&T operated in a regulated environment, the churn rate of the small businesses it served was negligible, and so were its related marketing expenses. …

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