QUALIPORT
The Best Customers For Your Shares

By Maynard Paton (TMFMayn)
May 19, 2003

Every company relies on its customers for success. However, there are good customers and there are bad customers. Ideally, businesses should focus their products and services on attracting the 'right' sort of client. In his book Competitive Strategy, management guru Michael Porter outlines the criteria for a preferential buyer. In general, the more customers a company has that fit Porter's guidelines, the less chance of a share price headache:

1. The buyer purchases small quantities relative to the sales of the seller.

Having a large, diverse spread of customers always helps to take the pressure off the top line. Anybody selling direct to the mass market, good examples being BT (LSE: BT.A) and Tesco (LSE: TSCO), aren't going to find a large proportion of their client base vanish overnight. Furthermore, small-volume buyers have less power to demand price concessions.

2. The buyer lacks qualified alternative sources.

Operating as the only game in town obviously gives immense power over customers. Indeed, the London Stock Exchange (LSE: LSE) raised some of its listing fees by a whopping 70% last year, yet there was no exodus from its market. Another good illustration is the regional shopping centre; with planning restrictions becoming ever greater, retailers wanting a high footfall have limited bargaining power with the likes of Liberty International (LSE: LII).

3. The buyer faces high fixed costs of switching suppliers.

Once you've entrenched your product within a customer's business, it can be very difficult to get kicked out. Switching from a Sage (LSE: SGE) payroll system for instance involves additional staff training, data transfers and typically a whole host of other unforeseen delays and problems. Unless a much cheaper rival comes in to view, the whole switching process can be more trouble than it's worth.

4. The cost of the product is a small part of the cost of the buyer's product cost and/or purchasing budget.

Good customers are those that don't look at the receipt too closely. In reality though, company accountants tend to scrutinise even the smallest of invoices. Thankfully, consumers are far less meticulous. To many people, it's of no real financial consequence whether a fizzy drink costs 50p instead of 40p, or whether the annual electricity bill comes in at £200 instead of £190.

5. The penalty for product failure is high relative to cost.

This is one of the more reliable ways of keeping your buyers keen. For example, by supplying highly regarded fire detectors and bursting discs, Halma (LSE: HLMA) has a developed very strong position with its customers. Few buyers scrimp on costs when there's a danger the penny-pinching could result in their head office burning down or a chemical plant exploding.

6. Effectiveness of the product (or service) can yield major savings or improvement in performance.

This is another good buyer strategy, as customers love to save money. Outsourcers such as Capita (LSE: CPI) and MITIE (LSE: MTO) continue to benefit as organisations carry on their crusade against costs. As long as the savings roll in, the buyer will never return to their bad old ways.

7. The buyer competes with a strategy to which the purchased product is perceived to contribute.

Companies with archetypal industry products clearly have a strong hand when dealing with buyers. If you're a sportswear store looking to cash in on the leading fashions, you're not going to get too far unless you stock adidas and Nike (NYSE: NKE) goods. On a similar note, British Sky Broadcasting (LSE: BSY) is prepared to pay vast sums to Manchester United (LSE: MNU) because the channel's strategy for gaining subscribers largely revolves around sport.

8. The buyer seeks a custom designed or differentiated variety.

Assuming copycat rivals are kept at bay, buyers will always pay up for a bespoke or differentiated product. For instance, while most new build houses look the same, McCarthy and Stone (LSE: MCTY) has carved out a niche in the development of properties for the retired. As such, buyers for McCarthy homes pay a relative premium due to the many desirable features inherently included.

9. The buyer is very profitable and/or can readily pass on the cost of inputs.

A weak buyer philosophy really, since no customer can pass on ever greater input costs ad infinitum. Probably the best example of passing on costs comes from the tobacco and oil industry, whereby consumers have grudgingly accepted the additional excise duty on cigarettes and petrol.

10. The buyer is poorly informed about the product and/or does not purchase from well-defined specifications.

Keeping your customers confused is by far the weakest buyer selection strategy. Buyers will wise up -- eventually. That said, the financial services industry has prospered for years from an endless stream of gullible punters. Until the general public wakes up to the numerous poor deals on offer, most banks, insurers and fund managers will keep on peddling their high charging, low value products.

More: Great Barriers To Entry

The author owns shares in Halma and London Stock Exchange.