Lollapalooza Effect: (A Charlie Munger term) When multiple cognitive biases reinforce one another within a group, irrational beliefs will take over.
THE PROBLEM WITH SMALL CUSTOMERS WITH UNPROFITABLE, AVERAGE-ORDER SIZES
When distributors create a Cost-to-ServE (CTS) model to estimate and rank customers by net-profitability, there are typically two, customer-group shocks:
- Some big-margin-dollar customers are big losers. Their many small-dollar orders and/or line-item picks total eat more CTS dollars (CTS$s) than their Gross Profit dollars (GP$s).
- And, 40 to 80% of all customers are small with small, average-order sizes. Their CTS$S also exceed their GP$s.
Warning! You can rapidly increase Small-Losers with a web-site marketing effort that wins new customers with terms that don’t insure enough GP$s per order.
Case example: a big distribution chain got these web-selling results: popped company sales by 8%; while customer and transaction counts doubled! So, 80% of all customers generated only 5% of the GP$s on 25% of all transactions. The new CTS-model verdicts:
- The Web Division was a net-loser
- Traditional distributor fulfillment costs exceed Amazon’s.
THE LOLLAPALOOZA DENIAL REACTION
The model stinks! Change it to turn little losers into winners. But, if 100% of operational costs are in the CTS model, then costs shift to turn other accounts into losers.
So, kill the CTS model and return to the traditional, data-free, Lollapalooza Belief-Bundle that includes:
- All sales and margin dollars are equally good (irrespective of related CTS)
- All costs are fixed in the moment, we can always take one more order (or thousands) without hiring any more CTS fulfillment people or reinventing CTS like Amazon.
- All new sales/margin dollars grow: economies of scale; profits; and rebates!
- Reps don’t like to see commissionable accounts as net-profit losers. Pretend they aren’t; be happy!
- Win more customers (of any size, kind) to replace defections and deaths to support 1-4.
- Little losers will grow into big profitable accounts.
- Little losers have higher average GP% which makes them (more) profitable.
- Everyone we listen to in the industry shares these beliefs (confirmation bias?). Stick with the herd!
- And, we’re doing OK financially. More volume will win.
Discuss belief blind-spots. Test them against statistical analytics. The opportunity costs of being distracted by burgeoning, Small-Order Busy-ness? Could you grow faster and more profitably by super-focusing on and better partnering the biggest, profitable, growing accounts? Using what buying statistics to spot lose-lose activity costs to fix?