I came across an article from 2012, “Is Your Company Hooked on bad profits?” by Fred Reichheld, a Bain Fellow, that is very relevant to today’s tech companies. Bad profits are revenues earned at the expense of customer relationships. These bad profits are generated usually with short-term revenue goals that over a longer period make your customers more likely to churn.
Examples of bad profits
As a consumer, you probably have many examples you can list of bad profits. Some of these are banks charging late payment or bounced check fees not in line with their costs. It could also be rental car agencies charging you more per gallon if you do not return your vehicle with a full tank of gasoline than you would pay for a fine French Bordeaux. It could be a wireless phone company charging you crazy international roaming fees. Maybe a fitness center locks you into a one year contract because they know you won’t be happy in a month. And it could be a free to play game company tricking players into spending premium currency by creating misleading buttons. Remember how AOL made you jump through about twenty agents to cancel its service? Unfortunately, these examples are too numerous to list.
The key feature of bad profits is that you are not delivering value to your customer or player. They are often driven by short-term profit or revenue goals. You may be trying to impress potential investors, increase your valuation for an acquisition or make your quarterly numbers more impressive for Wall Street, and bad profits can give you a short term boost.
The downside of bad profits
Some might argue that there is no such thing as a bad profit, but Reichheld shows how it has a negative impact on the value of your company. Bad profits turn customers into detractors. These detractors spend less, are more likely to switch to a competitor, provide negative word of mouth and demoralize employees who must deal with them (do you think those Comcast CS agents are going above and beyond?).
Bad profits can also impact your opportunities for an exit. Many companies today, as part of their due diligence, interview or survey a potential acquisition target’s customers to see if it would help or hinder their core business. When the target company is built on bad profits and customers are not happy, the potential acquirer looks elsewhere.
As Reichheld writes, “customers resent bad profits—but CEOs and investors should, too, because bad profits undermine a company’s prospects. Like the addicts they are, enterprises dependent on bad profits have no future until they can break their habit.” If you are building your business on bad profits, you are not building a business, you are creating a house of cards.
- Bad profits are revenues earned at the expense of customer relationships.
- Examples include exorbitant airline change fees, unreasonable bank fees, and contracts that lock users into a bad experience.
- Bad profits, while boosting short-term numbers, reduce the lifetime value of customers and make them more likely to churn.