How to Identify the Best Customers for Your Business

This post originally appeared on the MIT Sloan Management Review.

Many companies pursue growth opportunities without adequately defining who their ideal customers are. That lack of clarity can hamper profitable growth.

It’s difficult to start a venture that gains traction with paying customers. In the first decade of the 21st century, fewer than half of all U.S. startups were able to survive beyond three years.1 But it’s even harder to grow a company beyond certain levels of sales. Of the nearly 44,000 companies founded in 2000 and listed in the Capital IQ database — which includes public and privately held companies — fewer than 6% achieved more than $10 million in revenues by 2010, and fewer than 2% grew to more than $50 million.2 Why?

Once a venture reaches a critical size, its complexity greatly increases. Not only are there more “moving parts,” but interdependencies are more difficult to manage. The original business model must deal with new products or markets, and the early leadership behaviors that worked in establishing the business are often inadequate to manage and grow it. Most visibly, SG&A (selling, general and administrative) costs often accelerate faster than revenues, and because resource-constrained ventures cannot afford to burn through working capital, promising ventures are forced either to go out of business or to operate in small niches because they are unable to scale their sales activities. Even large, established corporations can face a problem with SG&A expenses: Between 2000 and 2010, production efficiencies reduced the cost of goods sold at the average S&P 500 company by about 250 basis points, while SG&A as a percentage of revenue didn’t change.3

Consider the case of an entrepreneurial company we’ll call BusinessProcessingCo. BusinessProcessingCo. (a real company whose name we disguised for this article) was founded in 2000 to provide Web-based outsourced payroll services to small and medium-sized businesses. By 2004, it had about $40 million in sales and 75 sales representatives with annual quotas of $600,000 each and target compensation of about $60,000 per rep. In 2004, the founder raised nearly $30 million from investors to develop new products and expand the business.

Read the full article.