When customer demand heats up, the first response of many business owners is to add capacity to maximize revenue. “We don’t know when an opportunity like this will come again,” they say, “so we would be foolish not to ramp up and capitalize on a great market.”

And that’s true. Maybe. Depending on the profitability of specific customer groups, it might be a much better idea to cull the client base first, and expand later…

Duds O’Denim is one of the nation’s oldest manufacturers of denim fabric, with sales to several dozen clothing companies, furniture makers and an occasional circus. Capacity utilization has been nearing the 92% level recently, and founder Billy Jeans knows that’s the point at which quality starts to suffer. Productivity rises as the lines get filled, but the team gets overloaded and more mistakes happen as the utilization rate rises into the 90s.

Denim socks are the hot new trend that’s driving overtime at the factory, and Billy’s sale reps, along with a few of the minority shareholders in his family, are pushing for new capacity to meet the demand. Billy’s a survivor, though, and he has seen too many of his competitors build capacity too far, too fast, only to collapse under a pile of unserviceable debt when sales soften even a bit. Denim socks are hot now, but Billy remembers the summer when everyone was buying denim umbrellas, the denim shoe fad, and the denim carpet fiasco. He won’t get fooled again.

Searching for his best options, Billy assigns his team to undertake two studies. The first is a classic projection of the costs and returns from expanded capacity. The second is a more unusual assessment of strategic customer relationships.

What makes a customer relationship strategic for Duds O’Denim? While the company is fully competitive on standard colors and lot sizes, Duds O’Denim is uniquely capable of producing consistent dye lots of custom colors, and its flexible manufacturing process ensures profitability on smaller production runs than its volume-oriented competitors. High-end designers, national retailers seeking to leverage their brands, and exporters to New Zealand have all relied on Duds O’Denim’s unique capabilities in these areas, enabling the company to profit strongly from its investment in these manufacturing niches. The customers he already has from these segments could utilize 80% of capacity on their own, and the addition of only a few more of these strategics could fill the rest of the plant.

Meanwhile, the company faces more of a commodity-pricing challenge among mass-market producers of blue jeans and denim jackets. Sales into this market are profitable, as a rule, but too many orders are won RFPs, and customers gained this way place no added value on Duds O’Denim’s expertise. Worse, the costs of winning these customers can make them unprofitable for the first six or seven months of a relationship, so the company doesn’t truly break even on a fully-burdened basis until month 14 or 15.

Billy asks the finance and marketing teams to analyze the opportunities that would be created by shifting sales from the commodity buyers to the more strategic, specialty clients. The specialty clients are more strategic for Duds O’Denim because they are a match for the company’s unique strengths. These clients provide the highest return available from the company’s prior investments in manufacturing expertise. Even more important, Billy realizes, Duds O’Denim is a strategic vendor to them, because their brands require offerings that others can’t provide, and they need Duds O’Denim to make it happen for them.

Three weeks later, the assessments come back. If Billy expands his facilities, he will need 14 months before the new capacity is on line. At 65% utilization for the new facilities, he will need seven years to break even on the full cost of the investment. After ten years, if all goes well, his return on investment will average out at 18%. If he works to shift his sales mix toward his strategic customer groups, though, the capital requirements are far lower and the return on investment much faster than would be the case with a plant expansion. At present, 35% of revenue and 60% of earnings come from the strategic customer niche. Each added percentage point of revenue from this group adds 2.3% to earnings.

Shifting the sales mix provides a faster return with less risk than plant expansion, and it provides a more predictable, profitable base of business to support new capacity in the future. Billy opts to focus on the strategic customers first, using both his commission structure and his pricing models to drive sales in a new direction. He redirects marketing and advertising expenditures to target the market segments inhabited by his current strategic customers.  To maximize predictability of demand and account retention, he creates new joint planning programs to make Duds O’Denim even more of a strategic vendor to the customers he covets most.

Because…Billy’s a survivor.

Rapid growth creates a number of opportunities, with wildly varying levels of expense and risk. Often, the most valuable opportunity isn’t to expand capacity, but to make the business bulletproof, and then build from a much stronger, more profitable, more sustainable foundation.

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Quadrant Five taps the full potential of strategic customer relationships to build both today’s profitability and tomorrow’s exit value. We make the critical connection between internal financial drivers and the value perceptions of A-List customers, generating returns for clients who must:

• Identify the shortest path to stronger profitability.
• Build enterprise value in advance of a liquidity event.
• Develop a strategic plan that can be implemented successfully.
• Perform customer/market due diligence on an acquisition target.
• Accelerate profitable integration of a merged business.
• Protect against customer turnover or lost sales.
• Recoup the cash that is wasted on unprofitable marketing/sales initiatives.

To learn more, please contact Michael Rosenbaum (michael@quadrantfivefocus.com) or visit our website (www.quadrantfivefocus.com).