Operating Lessons with Mike Botkin (Part 2)
Big Deal Small Business: Operating Lessons with Mike Botkin (Part 2)
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This week we’re covering Mike Botkin’s decision to raise prices on a third of his customers and drop a third of customers outright. If you missed Part 1, I’d recommend starting there.
If you’re all caught up, let’s dive in.
Pricing Decision
Mike had now noticed the issue, diagnosed the issue, measured the issue, and analyzed the data. He knows that he loses money on 1/3rd of his customers and 1/3rd of his customers are roughly breakeven (this was all covered in Part 1).
For the bottom 1/3rd, he had to decide whether to try to raise prices massively (25%+) to make them profitable, or just drop them altogether.
As he reviewed the customer list account-by-account, he noticed that these customers tended to be the highest touch customers – folks that required in-person customer visits, would call the office if the crew was 3 minutes late, etc.
In other words, not only were they losing him money on a crew labor margin basis, these customers were also taking up incremental time for himself and his office staff.
Dropping these customers made more sense then attempting large price increases to turn them into low margin customers who still sapped up operational capacity.
Instead, Mike could open up his crew capacity to go after higher value, higher margin customers. Bad customers have an opportunity cost.
For the middle 1/3rd of customers, Mike determined a reasonable price increase (5-20%) that would put them into an acceptable margin range for his business. To do that, he started with their current labor cost margin and added fuel costs, which are his two largest costs.
To measure fuel cost by customer, he used a simple average of cost of fuel per truck for a day divided by # of clients served in a day = average fuel cost per client. He had already done the work of optimizing routes previously.
To solve for price:
(labor cost + fuel cost) / (1 – target margin) = customer price
If the labor cost for a customer was $85 per visit and the fuel cost was $15 per visit, that’s $100 of cost per visit.
If Mike were targeting 35% margins after labor & fuel, then $100 / (1 – 35%) = $154 required price to the customer.
Lastly, he did take into consideration how these customers help his overall route density. For example, he had a few houses near one another that were lower margin than he wanted but provided route density. He left those untouched for now, but made a note to revisit those prices next year.
The net result of this work was:
A list of customers getting dropped
A list of customers with price increases for each
Communicating the Pricing Decision to Customers
For the list of customers getting dropped, the communication was handled through physical mail detailing the last service date. Mike gave these customers 3 weeks notice. While he got some blowback from customers that this was too short, most seemed to accept the timeframe.
Mike debated calling each of these customers. In the end, he determined the call wasn’t going to change the outcome or their level of annoyance.
In some cases, he did get angry phone calls, which he handled by explaining much of the math above. He positioned the decision in one of two ways:
I’m losing money on your property. If I continue to lose money on you, I’m not going to have a business in 5 years
This pricing only makes sense for a one-man shop with a buddy and a truck. It doesn’t work for a professional crew with high end equipment. So if they wanted the same pricing, they could find it, but they couldn’t get the same service.
For the list of customers being given price increases, he also used physical letters specifying the new rate and effective date. There were a handful he did call proactively due to long-term relationships with the business or other idiosyncratic reasons.
Communicating the Pricing Decision to Other Stakeholders
Choosing to drop roughly 1/3rd of your customers has a significant impact on stakeholders beyond your customers. From the crewmembers’ perspective, it could look like the business was self-immolating.
Mike was proactive, informing the crewmembers of the plan before they heard about it from customers. He told them not to be scared, and explained how adding 10 new high margin customers would make up for the 73 clients they had dropped and the 85 clients they’d put at risk.
That said, the #1 concern for your workforce is if they’ll get their full week of hours. Even if the business is losing money on those hours, they’d rather get paid to work hours than sit home and not earn money.
Mike assured them that they’ll stay filled up because of the landscaping projects in backlog. They had three months of backlog (irrigation work, mulching, etc.) that they could start working through immediately.
While in the end Mike probably has 10% too much labor after dropping customer, he’s confident he can fill those hours over time by more pursuing more project-based work. He can grow back into his labor capacity with projects that actually generate a profit.
Even with all that, some employees were very worried. He ended up offering a couple guys a $1/hour raise, which quieted their fears. After all, why would Mike be raising wages if the business was failing?
The other key stakeholder was the Seller. Many of these customers were his friends for 30 or 40+ years. He was born & raised in the community. He even got a call from a friend/customer who got dropped, asking him if the company was going out of business.
Further, a drastic operating change like this can be perceived as Mike didn’t think the Seller did a good job running his business.
Mike had to talk him through what was going on, but also set clear boundaries about the Seller’s role. The Seller ultimately respected the fact that this is Mike’s business now and while he didn’t love the decision, it wasn’t his decision to make.
The Results
Of the 85 customers that received price increases, only 4 decided to cancel their service. It is a recent change, so potentially more customers may drop once they’ve had time to find a new service, but for now it’s a resounding success.
Of the 73 customers that were dropped entirely, there were 17 homes all in one neighborhood. They called Mike as a group (via one homeowner) and asked what they needed to do keep the service going. He said he’d need 25% price increases across the board – the homeowner took a day to confer with the group – 15 out of the 17 houses accepted the price increase.
Another 2 clients from the dropped group called back asking Mike to name his price. In one case, Mike had to double the prior price to make the math work. The client accepted.
Beyond the financials, there are ancillary benefits as well. The crews seem more relaxed as the days are less hectic and the highest-difficulty customers have been dropped.
As part of the capacity release, Mike shifted from 3-man crews to 4-5 man crews, which elevates the Supervisors into true managers and gives them time to walk the properties. That process allows them to identify add-on landscaping projects to sell to their existing customers.
With the excess labor capacity, Mike has worked his landscaping project backlog down to 2 months and will get it down to 3 weeks over the next month, which gives him 3 weeks to fill the pipeline back up with this add-on work.
All things considered, while it is still early days, the operating decision appears to be a resounding success. Hats off to Mike for executing and making hard decisions within his first 6 months of ownership.
Conclusion to Part 2
Mike told me that he walked into the business with a list of 200 things that he wanted to change in the business. Instead, he arrived and started getting punched in the face daily with new problems and people management issues.
At the end of the day, an SMB owner’s #1 responsibility is people management. All our business tactics & strategies need to be communicated and then executed by the team.
If Mike hadn’t figured out a way to communicate the importance of tracking time to his team, they wouldn’t have provided him with useful data, and he never would have solved the pricing issue.
Another key learning from this process is that not all revenue is good revenue. This may seem obvious in hindsight, but is hard to identify from the outside looking in.
Altogether, this was an inspiring story for me and one that I’ll keep in the back of my mind as I diligence potential acquisition targets.
Thanks again to Mike for his willingness to share openly about his experience. You can follow him on Twitter here.
Let me know what you thought of this guest post format — I’m planning to feature more searcher-turned-operators in the coming weeks & months. Hit reply to this email or find me on Twitter.
Thanks,
Guesswork Investing