Businesses with fewer than 100 employees account for 98 percent of all companies in the United States, roughly two-thirds of the country’s jobs, and one-third of its gross national product. They also make up a significant part of the action in many industries: half of the turnover in the travel industry, for example, and one-third in the telecom-munications industry, worth $80 billion and $57 billion, respectively.

In other words, small business is big business—above all, because small companies can often be targeted, profitably served, and retained without the discounting that large corporations demand. A transportation company found that its biggest accounts were earning a sorry 2 percent before taxes, as opposed to 10 percent for a standard small account. The disparity was explained chiefly by the high level of discounts offered to large customers (an average of 18 percent for "strategic" companies) as against 1 percent for their smaller counterparts. The better pricing structure more than offset the higher cost of serving small customers.

Merrill Lynch realized the potential of small (and medium-sized) businesses in the early 1980s, when it created a division to focus on their needs. Other companies too are realizing that serving this market effectively is essential now that aggressive growth and revenue goals are intensifying the competition for the largest customers. Ameritech, Federal Express, Wells Fargo, KeyCorp, and Dell are among the businesses that have increased their revenues and profits alike by finding ways to target, attract, and retain small customers.

Why, then, don’t more companies join the party?

The problem

Serving small businesses poses three hard-to-manage challenges: identifying your profitable customers, acquiring new customers cost-effectively, and reducing what you spend to serve them.

It is hard to identify profitable small customers because these businesses are so diverse. Indeed, there are millions of them, and many defy straightforward classification into distinct, actionable segments. Traditional demographic segmentation by size or industry rarely helps.

Acquiring small customers cost-effectively is tough, as well, because lower volumes per customer rule out the one-to-one sales model typical for large customers. (Direct sales costs, which can be as low as 0.05 percent of sales for the latter, can run above 5 percent for the former.) At the same time, the sales process may be no less complex for small than for large businesses, because small ones do not have sophisticated purchasing departments.

Finally, keeping down the cost of service is difficult, since besides lacking the purchasing expertise of large companies, small ones may not be able to afford an internal support infrastructure and thus look elsewhere in the value chain for missing expertise, from postsales computer support to financial advice for loans. Many products, such as computer servers and PCs, are "mission critical" for small businesses in a way they almost never are for individual consumers. This increases pressures—but not revenues—exponentially.

Yet companies catering to these small clients cannot afford to let up on service, because they have a higher "churn" rate than larger clients do. Perhaps 5 percent of a company’s largest customers might turn over in a given year—but more than 20 percent of its smaller customers. For one thing, smaller businesses have a relatively high failure rate; about 20 percent of them go out of business in the first year. Second, small businesses have more choices than they did in the past as more companies wake up to the opportunity of serving them. In 1984, when AT&T operated in a regulated environment, the churn rate of the small businesses it served was negligible, and so were its related marketing expenses. In 1995, the churn rate exceeded 20 percent, and AT&T more than doubled the portion of sales it spent on marketing, to 13 percent, from 6 percent.

Two wrong responses

In the face of these challenges, many companies, convinced that small customers will generate little or no profit, are scared off. They therefore spend most of their time and resources chasing "key" or "national" accounts at the poor profit margins already noted. Other companies do recognize the potential—but not the increased cost and complexity—of serving small businesses. They try to apply their existing large-business model to this segment, an approach that typically yields disappointing returns both economically and in customer satisfaction.

Nonetheless, some companies do succeed in selling their goods and services effectively to small businesses. In the computer industry, where such companies as Compaq and IBM have traditionally focused—profitably—on medium-sized to large companies, Dell has used its build-to-order model to match more closely the diverse needs of smaller customers. According to International Data Corporation/LINK’s 1997 Small Business Survey, Dell’s direct-response channel is the first choice of US businesses for future PC purchases; more than 35 percent of respondents chose it.

Companies aiming to improve their revenues and profits from small customers should ask themselves three questions:

1. Which specific small businesses are most attractive?
2. How does a company target attractive customers without spending too much?
3. How does a company develop a pricing and delivery model that permits it not only to serve small businesses but also to make a reasonable profit doing so?

Understanding where your profits are

Different kinds of small businesses represent different kinds of opportunities

Companies often treat small businesses as a single monolithic segment or, at best, categorize them by industry. But different kinds of small businesses represent very different profit opportunities for the companies that would serve them. One bank, for instance, found that 20 percent of its small customers were responsible for 90 percent of its profits from small customers. Enterprises in many industries report similar results. The transportation com-pany mentioned earlier found that 40 percent of its small customers accounted, in a sense, for more than 100 percent of its profits, since these customers were subsidizing other business, which was losing money. Both the bank and the transportation company found that profit had less to do with demographics than with how customers banked and the frequency of deliveries.

To respond to this profitability problem, the transportation company shifted from a simple volume-based segmentation system to a system that segmented customers by their needs. The first task was to understand the drivers of profitability. Here, the product mix was most important, followed by volume. The company therefore examined the product, service, and brand image requirements of all its clients to identify which of them would probably generate the most profit given the particular mix of products they used and the volumes they ordered. When all this had been taken into account, the company found that it could organize its customers into six segments by their likely profitability. A customer in the most profitable segment might warrant a direct sales call, a customer in the average segment a telemarketing call, and a low-profitability customer no calls at all.

The same segmentation system holds for service levels. The most profitable customer might be given a separate telephone number to help it reach dedicated sales representatives; others might receive service on a first-come, first-served basis. At the opposite extreme, customers who cannot be served profitably might be ignored. Many companies find it hard to do this. They should recognize that they drag down earnings by using profitable customers to subsidize unprofitable ones. Destroying value in this way means fewer dollars to invest in products and services for valuable customers, who might thus be wooed away by competitors.

Similar examples of strategic segmentation can be found in banks, computer manufacturers, and insurance companies. One bank segmented its small customers along two dimensions: price sensitivity and delivery preference ("high touch" versus "low touch"). It then redesigned its approach so that each segment was served appropriately. For the "access" segment of customers, who sought low-touch service at a moderate price, the bank offered remote facilities, including 24-hour service and PC-based trans-actions. For the "price shopper" segment, which wants personal service but at a low price, the bank created simple off-the-shelf products that a generalist member of the branch staff could sell.

Of course, making this approach work involves putting in place the necessary staff skills. In the bank’s case, the new segmentation was accompanied by initiatives to drive knowledge down to the branches through improved central sales support, including referrals, improved training and selling tools, and better management of sales performance. Gradually, products were simplified, hiring criteria raised, and compensation increased to support and sustain the changes.

Winning new customers more effectively

How does a company commit the resources needed to win new small-business customers without spending more than they are worth? Ultimately, through a kind of leverage, by trying to make indirect mechanisms yield benefits more typical of their direct counterparts.

Treat the indirect sales force as a direct sales force

Most companies cannot justify using a direct sales force, even if they have one, to pursue small customers, so they must get their messages out through remote or indirect channels. Unfortunately, indirect channels are hard to influence.

In the PC industry most large manufacturers, such as Compaq and IBM, have two tiers of distribution. Small-business customers are served through more than 50,000 distributors and resellers. Studies by industry experts have shown that these intermediaries have an influence of as much as 80 percent over a customer’s choice of brand. But how does a manufacturer educate and motivate the sales forces of 50,000 third parties to sell its product rather than the competition’s?

One PC manufacturer tried to do so by offer-ing distributors money in the hope that it would trickle down to resellers in the form of marketing incentives. Unfortunately, the manufacturer found that the money usually did not reach the resellers and that when it did, the incentive was not strong enough to make them tip the scales in the manufacturer’s direction. After interviewing the resellers, the company found that tools to help them sell its brand quickly were the key to persuading them to recommend the brand. The manufacturer then offered resellers regional training, easy-to-sell solutions, and improved sales collateral, such as marketing information and displays.

An insurance company, which had previously promoted sales to small businesses by investing in cooperative incentives and promotions (under-taken jointly with its indirect sales channel, the insurance brokers), decided instead to provide support tailored to the brokers’ needs. The company prequalified and tracked its leads, ran direct-mail campaigns jointly with brokers, developed a tool kit to simplify sales procedures and sales con-version, and had its representatives make sales calls with brokers and coach them. The type and level of support for any given broker reflected the potential of its base of small customers and its skill in serving that market. As a result, the company increased its close ratio for small-business customers to 20 percent, from 7 percent. Commissions rose by 10 percent.

For both the PC manufacturer and the insurance company, the winning strategy involved making a few targeted investments in the indirect channel, which in effect was treated as though it were the direct channel. This approach costs more, perhaps, than a standard indirect-channel strategy but is much less expensive for a company than running its own sales force.

Form partnerships and alliances

Whether a company is trying to win new customers or to sell new products to current ones, it should realize that it will not be able to do the job alone; it must leverage third parties through partnerships.

Partnering has long been a buzzword in business, but most so-called partnerships are no more than thinly disguised price-discount programs. Many credit card companies, long-distance telephone service providers, and service companies develop such partnerships. One between a credit card provider and a package delivery firm, for example, might give price discounts on package deliveries to all holders of the first company’s credit cards. This is a real benefit for the credit card company and its cardholders but may not increase volume for the package delivery company if the cardholders are current customers and merely receive a discount on services they already use.

Is a partnership merely a price discount?

Two questions help companies determine whether a partnership is really a mere price discount:

• What new value, apart from a lower price, does the customer receive from the product or program?
• Does the program genuinely target new customers or offer current customers new products, or does it merely reduce revenues from current customers?

Companies that succeed in the small-business market avoid partnerships based on price discounts and rely instead upon focused partnerships that emphasize the creation of value both for the partners and the customer.

First Union Bank, for example, has relied upon various value-adding partnerships to serve the small-business market. It works with ADP and Hartford Insurance to supply small businesses with one-stop financial shopping, such as banking, insurance, payroll processing, and tax-filing services. In addition, the bank teams up with Intuit to provide easy access to customer accounts using Quickbooks and Quicken software.

Another financial institution, Mellon Bank, entered into a partnership with the American Dental Association (ADA) to offer that organization’s members a broad menu of financial products and services. The arrangement gives Mellon Bank access to a large number of small businesses around the United States, as well as the support of the ADA’s powerful brand name—all without having to add costly bricks and mortar. Two other banks have entered into partnerships with leading copying companies to provide a variety of frequently used financial and nonfinancial services to small businesses in a shared facility.

Leverage technology to cut the cost of acquisition

The facts—or stories—speak for themselves. Take Cisco Systems, a network products company. Its first site on the World Wide Web merely presented basic information about the company and its products. When Cisco saw how many "hits" the site was getting, it was transformed into a full-scale, transaction-oriented Web site that permits customers to configure products, place and track orders, and receive basic support. Today, 15 percent of Cisco’s sales derive from its on-line channel.

Dell famously embarked on a similar strategy, launching a Web site for ordering personal computers in December 1995. By mid-1996, it had added facilities for custom configuration, cross-selling, and up-selling (getting customers to buy a computer based on Intel’s 450-megahertz Pentium II, say, when they had meant to buy one based on a slower microprocessor). Month-to-month sales growth hit 20 percent; the cost of customer contacts and acquisition fell by half; and repurchasing levels were higher than they were for customers using other channels. Although there is no exact segment-by-segment breakdown, Dell has indicated that a significant part of its Web business comes from small businesses or from resellers serving them.

National Semiconductor, meanwhile, communicates product offerings and gives presale consultations to more than one million geographically dispersed design engineers. Each day the site receives 20,000 visitors and downloads 7,400 data sheets. The month-to-month growth of registered engineers has reached 20 percent. Besides offering price information and product speci-fications, this site supports order entry and delivery.

In the banking industry, Wells Fargo has historically relied on branch traffic for loan business. But the loan approval process was lengthy and paper-intensive, and loan prices varied widely. To identify the most attractive prospects, the bank decided to shift to techniques involving more centralized database analysis, credit scoring, and targeted marketing, and it used direct mail to offer prequalified loans to prospects around the United States. According to the Bank Administration Institute,¹ the approval process was redesigned to require only half a page of information, and approval times dropped to 15 minutes, from more than 24 hours. Wells also began to use risk-based pricing, and it increased credit lines to anticipate customer needs. Acquisition costs dropped by 90 percent; the net present value of a typical small-business loan more than doubled; and the company’s share of US commercial bank loans of under $1 million rose to 4.3 percent, from 1.4 percent, between 1993 and 1996.

Meanwhile, several other banks, including Hybernia Bank and KeyCorp, have launched quite similar programs. Statistical models have led these institutions to conclude that fewer than 20 pieces of data (out of 400 that are typically collected by banks for credit scoring) accurately reflected the credit risks of lending to small businesses. This realization significantly reduced the cost of acquiring loans.²

Cut the cost of service any way you can

Spending less to acquire customers is good. Spending less to serve them is better. The same technology that cuts the cost of acquisition can also cut the cost of service. Cisco’s Web site lets customers configure a system on line. The Web model not only prevents them from making impossible orders but also reduced errors by 30 percent. In addition, customers can easily check the status of their orders on line. The heavy use of the Web site has sharply reduced the burden on Cisco’s call center, while on-line access to documen-tation saved the company $150 million a year in publishing costs.

Companies should not confine themselves merely to setting up Web sites. Recognizing the different needs of small-business customers, one PC manufacturer wholly rethought its product design, manufacturing, and delivery systems. It cut back on features of little value to small businesses, cut prices, and created hardware and software bundles that were easy to install and operate. Restructuring the manufacturing process to accom-modate smaller batch sizes permitted this company both to meet the needs of small customers and to control costs.

Dell and thousands of "build-your-own" resellers have now moved to a build-to-order rather than a build-to-forecast model; components and unfinished goods are held as inventory. This approach has transformed product offerings from "you get what we have" to "you get what you want" and helped resellers dominate the small-business market. Other PC makers are now starting to give larger customers the same variety and flexibility.

Meanwhile, in the financial services industry, one bank found that its 24-hour automated telephone and PC interface service (with an option to speak to a representative) took over a large part of its basic customer inquiries and greatly reduced their cost. The bank had already cut transaction expenses from $10 for a face-to-face encounter with a branch teller to $5 for a human response in a call center. By introducing on-line and automated telephone transactions, it brought the cost down even further, to 28 cents. This bank was among the first to offer a tailored service to small businesses.

Building a small-customer focus and capabilities

So far, we have discussed tactical initiatives for selling effectively to small businesses. Beyond tactics, of course, lies the broader question of how far a company’s internal structure, skills, and systems promote the ability to serve small customers, as well as a commitment to do so. Sometimes, it actually pays to reorganize a company, at least in part, around small businesses.

A telecommunications company, for example, decided to reorganize itself by customer markets, including one for small businesses. In the past, the company had been structured by function: marketing, sales, service, and so forth. Within each function, customers had been ranked according to size, so the smaller the customer the less attention it received. All sales and service activity was reactive. The reorganized company created a unit to focus on small businesses. This unit in turn segmented its customers by their needs to create tailored products and to offer proactive, coordinated sales and service through small-business specialists in dedicated telephone centers.

Similarly, a payroll and employer services company that once hardly bothered with small customers resolved to create an emerging-business service unit focusing on firms with fewer than 100 employees. The unit now has full autonomy, its own staff, and an independent profit-and-loss account.

It is by no means always necessary to undertake a full-scale reorganization, however. The key question a company serving small businesses should ask itself is whether each customer gets the level of attention appropriate to its potential value and the type of attention best suited to its needs. The supplier has to understand the organizational structure of a small business, including the frequent lack of infrastructure and the possibility that the supplier might be talking to the owner and not to an employee. And of course, the supplier must be able to identify the right product or service to meet the customer’s requirements and must meet them expediently and economically.

Most companies do not make much money from small customers. Part of the problem is intrinsic to the customers themselves, but not all of it, by any means. Small customers can provide significant earnings to companies that find ways to acquire and serve them effectively. A smarter segmentation scheme, as well as the flexible deployment of partnerships, remote or indirect channels, and technology, will make a good start.