Startup anti-pattern #5: Bad Revenue

First, a blast from the past which some of us might remember.

As a kid growing up in the 80s, I was a movie junkie and rented movies from Blockbuster several times a week. I’d binge-watch the movies I loved (I’ve probably seen the entire James Bond series 20 times). Back in the 80s, Blockbuster was somewhat okay—they had policies around late returns, but those weren’t draconian, and the late fees were manageable. I could pay a reasonable amount of money if I wanted to keep a VHS tape and watch it on repeat.

At some point around the turn of the decade, Blockbuster decided to change its policies. I’m wildly speculating that someone at Blockbuster’s Corporate recognized an opportunity to make a few more bucks from a (probably significant) subset of customers who were late in returning video tapes. Blockbuster decided to charge exorbitant late fees for no real reason.

It was frustrating and kept customers on their toes. The brand image deteriorated. Employee discretion policies regarding charging late fees became increasingly aggressive (the “my dog ate my VHS tape” excuse quickly became frowned upon), not surprisingly, given the incremental revenue lift late returns delivered to the chain. Blockbuster became the one shop on my street I was always trying to avoid.

Unfortunately for Blockbuster, they made the wrong move. Their choice to create significant friction with customers left them completely open to alternatives. We all know how the story ended. Netflix came about and was happy to lend customers DVDs for as long as they wanted to binge. That simple tweak, putting customers first, made a big difference and eventually (among other things, such as streaming and online content piracy) led to Blockbuster’s ultimate demise.

What is it?

It might seem odd, particularly in what feels like a Tech recession (or potentially a broader recession), to talk about the concept of “good vs. bad revenue”. Some of you may be thinking that “Revenue is revenue; all revenue is good!” Unfortunately, that is not always the case.

“Bad revenue” is revenue that comes at the expense of building the long term viability of the business. Below are a few examples of “Bad Revenue”:

  • Comes at the expense of the relationship with customers – For instance, a company that hinders their clients’ ability to cancel when they want to or sells something overpriced, taking advantage of the customer’s needs. This could lead to Churn, low NPS scores, and angry clients which can hurt your organization’s reputation.
  • Negative or very low contribution margin – The deal with the specific customer is either unprofitable or the margins are significantly lower than those with “good revenue.” The opportunity ends up negatively impacting the company’s financial resources.
  • Outside of target audience – Revenue opportunities outside the company’s customer target are more difficult to acquire, and win rates are significantly lower. Even if we win the customers, the ability to create a delighted customer is at risk because the company and product are not set up to win the relationship. Further, those opportunities don’t help your organization learn and evolve.
  • “Customer from hell” – Customers who are over-demanding or just plain rude can lead to frustration and churn among the company’s employee base. These customers are unlikely to become an advocate for the business and won’t be good references either.

In contrast, “good revenue” typically generates strong profitability because it is from deals that we know we can support well. The customer is delighted and the product helps them achieve their goals. The customer scores high on NPS scores and is proud to share their delight, serving as an advocate and reference. Engaging with the customer strengthens our collective understanding of our customer’s needs and helps cement our position in the market. It enables us to more easily find and pursue additional deals and revenue.

Why it matters?

Bad revenue can drain the company’s resources and divert management and employee focus toward less productive venues. Good Revenue informs your next decision. Bad Revenue distracts you from it.

Focusing on good revenue could mean that the company probably won’t grow as fast as some of our competitors. However, it does mean that customers will genuinely love the company and want to work with us over a longer period. In the short term, you might miss your goals, but it will be a win in the long term.

Furthermore, bad revenue often comes at the expense of good revenue creating a high opportunity cost. Instead of focusing on the right set of customers, the company’s (often scarce) resources are continuously diverted to energy-draining customer relationships.

Almost every professional has had the unfortunate experience of being stuck in a relationship with a customer who they can’t possibly satisfy. The ongoing frustration could eventually lead to employee dissatisfaction and churn.

Diagnosis

Sadly, too many salespeople are directed by their management to grow revenue at all costs and don’t pay attention to finding opportunities that create “good revenue”. They end up casting a wide net in their prospecting to hit short-term revenue goals, at the expense of the long-term health of the business.

There are several ways to diagnose “Bad revenue” in your organization:

  • Profitability is declining, while pricing remains the same – This can be a signal that 1) the company is becoming less efficient, or 2) The company is taking on bad revenue.
  • Employ customer profitability analysis – Knowing your average customer profitability and conducting a customer level profitability analysis can help detect relationships which are not making a positive impact on the business. In more mature organizations, this type of analysis should be made on an ongoing basis, or at the minimum at renewals. There are better tools these days to assist with this analysis, such as Lumopath AI (apologizes for the shameless plug to a Recursive Ventures portfolio company).
  • NPS scores dropping – Aggregate NPS scores are a great high-level diagnostic tool. Once you spot a negative trend, the trick is to go beyond the aggregate, analyze deviations, and stack-rank customer satisfaction on a per-customer basis. It can be helpful to continuously stack-ranking individual customers and analyzing the bottom quartile of responses. Beyond just better understanding the challenges involving your target market, the exercise can also help understand which types of customers the organization should avoid moving forward.

Misdiagnoses

One common misdiagnosis occurs when companies don’t properly consider “land and expand” opportunities, thus undervaluing the customer relationship. Another form of this is short-term or miscalculations of lifetime value (LTV) of a customer. Instead of considering the long-term potential of the relationship, the company doesn’t properly assess the opportunity and doesn’t end up making the right long-term choice for the business because they think it’s “bad revenue”, but in practice the customer has much more to offer longer term.


Refactored solutions

Once diagnosed, the refactoring of this anti-pattern requires changing the organization’s mindset and approach to sales and customer success. A few ideas on how to refactor best:

  • “Firing” customer(s) – If your organization is indeed facing a ‘customer from hell’ or bleeding cash servicing a customer, the easiest solution is to part ways.
  • “Improving” Prices – Improving pricing can go both ways. If the customer engagement is not profitable, you can raise prices to achieve the organization’s target profitability goal. Alternatively, if the pricing isn’t sufficiently correlated to the value delivered to the customer, and the customer feels that they are significantly over-paying for the solutions, you could lower the price to help retain the customer for the long term.
  • Institute performance-based compensation plans that reflect the overall “health” of a deal – salespeople often get most of their compensation with commissions. Building a scheme that accounts for profitability, Lifetime value, and customer satisfaction goals pushes sales and customer success to prioritize good revenue over “bad” revenue
  • Build organizational values seeking “win-win” situations with customers – Win-win situations help build a healthy customer relationship. Obviously, the company needs to strike the right balance and capture value, but avoiding “harvesting” or short-term thinking tactics lead to happy customers, retained over longer periods, and producing higher NPS scores and LTV.
  • Embrace Market Research and go-to-market best practices – Start by conducting comprehensive market research to identify your target audience. If possible, avoid diverging from your target audience to focus on the customer you can deliver the most value to first. The company will eventually have to go outside of initial target customer “comfort zone,” but it’s best to avoid doing that early if you have sufficient “runway” with your core target audience.


When it could help?

Sometimes, organizations need revenue badly, and have to accept bad revenue. However, companies should do it with eyes wide open, understanding what they are doing, why they are doing it, and what risks they are taking on.

A few examples in which bad revenue could make a positive, albeit short term, impact:

  • Bad revenue could be a necessary evil when the organization needs to fundraise soon (and need to show revenue momentum to investors).
  • Related to the previous point, Bad revenue could help contribute to M&A outcomes, with buyer paying a premium for growth or a wider set of customers.
  • New market penetration – A company endeavoring into new customer segments and markets might experience a stretch of bad revenue as part of their learning process. This bad revenue could be a necessary evil required to learn the new target market, fine-tune the product offering, or discover the right pricing scheme. If the bad revenue is a means to an end – better understand the market and eventually reaching a good revenue state – it could be an justifiable investment.

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