Ask the average CEO to describe his or her company and you’ll probably hear, “We make the world’s fastest semiconductors” or “We offer a broad range of financial services.” This misses the crucial point, says Larry Selden, professor emeritus of finance and economics at Columbia University and coauthor of Angel Customers and Demon Customers: Discover Which Is Which and Turbo-Charge Your Stock. A company, Selden contends, is really a portfolio of customers — some great, some good, and some absolute demons. The organizations able to tell them apart and treat them accordingly will dominate the 21st century. FuelNet spoke with Selden about customer retention management and more.

FuelNet: One of your many counterintuitive ideas is the 150–20 rule. What is it, and why is it so critical to customer retention?

Selden: Frequently, as much as 150 percent of a company’s profits tend to be generated by 20 percent of its customers. That sounds mathematically impossible if you assume that all customers are profitable. But in fact, the bottom 20 percent tend to lose 100 percent to 120 percent of profits. And a manager should know who those customers are and why they generate the profit or loss they do.

FuelNet: But if a product has a positive gross margin, isn’t every customer who buys it by definition profitable?

Selden: Not at all. The worst retailer on the planet probably has positive gross margins. But there are a lot of other costs associated with running the business: marketing, sales staff, inventory, the brick-and-mortar costs of the store, the CEO’s salary and airplane. And some of this varies with the customer, but all of it has to be covered.

FuelNet: So the trick is to accurately allocate costs and profits to individual customers. What do you say to a CEO who claims that this is impossible?

Selden:  You never hear that from profitable companies, only from unprofitable ones. This kind of analysis is hard, yes, but it’s not optional. You’ve got to understand who’s contributing to profit and who’s not, especially because so many companies have these lumpy distributions. The action is really in the tails, the highest and lowest profitability deciles. If I have a churn rate of 30 percent, boy does it matter what decile that 30 percent is in. If I’m churning my top couple of deciles, I have a huge problem. So the first step is detective work, figuring out who’s where. Once you’ve figured out who is profitable and who isn’t, the next step is to make it actionable by segmenting these customers into categories with common needs. Then you devise value propositions to meet those needs and enhance their profitability.

FuelNet: If some unprofitable customers are salvageable and some aren’t, how do you tell the difference?

Selden: Most unprofitable customers aren’t demons. Some are unprofitable because I’m doing something stupid. I’m not stocking the right product selection or whatever. This can be fixed fairly easily once it’s understood. Others are just not a good fit for what I’m offering. I’m not designed to serve them well, and I should more clearly communicate what I’m about so they don’t tie up my sales force and get frustrated.

FuelNet: That leaves the true demons. When you identify one of these characters, what’s the next step?

Selden: If you go to your favorite coffee shop, every now and then you’ll see someone who grabs all the napkins and sweeteners and takes them home, so the rest of the customers don’t have anything. At a clothing store you’ll see people who buy a party dress, wear it, and return it the next day. These are demons, and as a group they can be extremely unprofitable. One way to deal with them is to change the terms of the transaction. At your favorite coffee shop, they can give out the napkins and sweeteners as you get your coffee. If you’re a high-end clothing retailer and a customer has returned 100 items over the past three years, you should start saying, “Sorry, but this item is non-returnable.”

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