Is it possible to have too many clients? The initial response is typically, ‘no way, the more business the better’. But what if there is a point at which any additional client actually costs more to service than the fee you receive in return? Welcome to the world of marginal analysis.
So how can this happen? How can you actually lose money by servicing additional clients? And is this necessarily a bad thing?
Let’s work through an example, using any service based enterprise where you pay staff to deliver a service to clients. It may be a clinical service, hairdressing or some other time based service (where the customer charge is related to time spent with them or their project).
Firstly consider your fixed costs, the rent, insurance, telephone, bookkeeping, cleaning and other business expenses that are not related directly to delivering a client service. These costs exist whether or not you have any clients at all, and must be paid from cash flow or cash reserves (when times are slow). The other costs are variable; they are only incurred when a client is being attended to. Examples include practitioner wages, consumables (gloves, gels, oils, etc), and any extra energy or occupancy costs that arise if a service is delivered outside of your core business hours.
A brief word on practitioner costs; if you employ staff on salary for fixed and regular hours per week they are a fixed cost up to this limit. If however they are required to work overtime or out-of hours any additional wages are a variable cost as they are directly related to client service. If you pay your team on a casual or contracting rate whereby all their income is dependent on client flow then the whole amount could be considered a variable cost. If you have a blended package of a retainer and commission there is elements of both.
Our first assumption is that you get to set your own pricing structure, and that this is based on some logical calculation to cover all your fixed and variable costs and hopefully have some left over (known as profit, see this earlier post for more on fee setting). Now the clients start to flow in, and the income generated is quickly burned off by all your fixed costs. Once these fixed costs are covered you can now attribute cash flows to meet the variable costs for each consultation, visit or job. Again, your price structure will have some room for these costs up to a point, and this point is generally your usual operating hours, appointment frequency and staff allocation. But what happens when you have the opportunity to supply beyond this point? When the demand for your services exceeds your usual capacity to supply and you ask staff to extend their hours (overtime) or pay them more to do more (increased commissions).
The temptation to extend your scope to take advantage of the increased demand is strong, but does it make sense from a business perspective? Your fixed costs don’t increase, but your variable costs do as does your cash flow (income). There is a marginal increase in costs to provide this additional supply (extra wages, energy costs, admin support at front desk, consumables), and a marginal increase in revenue from the additional service. However if the marginal costs exceed the extra marginal revenue generated you will actually be providing the service at a loss.
Still doesn’t seem possible, does it? How can you be charging out one or more extra jobs but not make any money from them? It now comes down to a concept known as marginal analysis. The marginal cost is the change in total costs (fixed and variable) divided by the change in quantity of supply (the extra services). So if your fixed costs per client service (easily calculated from your history of expenses and number of services billed for) are $45 and the variable cost is usually $35 your client fee of $90 leaves you with a $10 surplus. However when you have additional variable costs to get that one extra client, they increase to $45, you are now breaking even. If the variable costs go beyond this, if the additional cost exceeds the marginal increase in revenue, you are now operating at a loss for each additional client.
I have seen this problem arise in clients’ practices where the commission for a therapist bumps up when they achieve a target number of client services for the week. In one example, the per patient commission rose from $20 to $50 once 90 treatments were achieved in a working week, yet the fee paid by the client did not change. Consequently the business was losing $25 per appointment after 90 treatments, to the advantage of the therapist. The therapist was strongly motivated to achieve their target because beyond it lays the riches of doing the same job for more than twice the commission. Interestingly, this therapist became very skilled at working longer hours early in the week, making target by Wednesday and reaping the benefits for the next two days.
There are two interpretations here; firstly you may consider a small loss quite tolerable in building the business with a view to expanding staff numbers down the track. Or you may seek to recover the increased variable costs by loading the client fee for example adding an ‘after hours’ or an ‘emergency consult’ premium.
The main issue is to be aware of what each consultation costs and ensure the fees charged more than cover that amount.
Craig Allingham EMBA APAM