How to Spot The Nightmare Clients Who Can Kill Your Business

A box of lukewarm chicken fried rice waits on your desk.

But you lost your appetite.

It’s 9 pm on a Wednesday night and a stack of income statements sits next to the box of fried rice. No matter how many times you rework the numbers, the reality doesn’t change.

You’re scared to death your business is in serious trouble.

Your profits have either taken an extended vacation or your sales pipeline has withered to nothing. Or, maybe it is just a tingling feeling that the business is off-track.

You want to sort it all out. But how?

Well, it may not be a problem with your business.

It may be a problem with your clients.

As the owner of a consulting or professional services firm, you know toxic clients. Those clients who are never happy with your work or who don’t understand the meaning of “Net 30” on their invoices.

But some clients go beyond toxic: They can become nightmares. And if a nightmare client slips by undetected for too long they can do long-lasting harm, even putting you out of business.

After years of running and advising professional services firms, I’ve learned to avoid the following nightmare clients: The low-profit client, the misaligned client, and the dead-end client.

Let’s look at how to spot each of these nightmare clients before it’s too late.

Low-Profit Clients Will Starve Your Business to Death

Cash is the lifeblood of every business.

Without adequate cash on hand, a business cannot pay its overhead costs or owner distributions. And, it certainly can’t grow.

Starving companies will just grind along, on life support. Or their doors may be shuttered altogether.

In a services business, operating capital (cash available to run the business) comes from profitable clients.

No profitable clients equals no operating capital.

Build a healthy, growing business by eliminating every low-profit client who isn’t contributing its share to your bottom line.

What is a Low-Profit Client?

There are different types of profits that a business tracks. To sniff out low-profit clients, though, it’s all about gross profit.

The more it costs to service a client, the less that is left over to pay for things like rent and advertising. Oh, and your salary.

Hopefully, you’re starting to see the problem with low-profit clients.

How to Spot Your Low-Profit Clients

You will be disappointed to hear this: There is no quick way to tell if a client is profitable. It takes effort and discipline to track client profitability.

The good news is the process is straightforward. You just have to do it.

To start, establish your minimum acceptable gross margin¹ per client. This is the minimum gross margin that you would like to see generated from a client account.

Many services businesses shoot for a minimum of 40 percent. Others expect the minimum closer to 60 percent.²

Remember, though, you likely provide several different services to your clients, each with its own gross margin. You need to focus on the combined margin for all the services provided.

To spot your low-profit clients:

1. In QuickBooks, allocate revenue and expenses to each client. The expenses should be only those directly related to servicing the client, e.g. salary, travel, equipment or software, or server costs. (Yes, this could be a lot of work.)
2. Sort all your clients by gross profit margin, from highest to lowest.
3. Identify all the clients who fall under your minimum acceptable gross margin.

Any clients falling below your minimum threshold need to be addressed immediately. They are draining your business of cash.

Misaligned Clients Lead Your Business Astray

Remember back when you first launched your business?

You had a vision. It was so tangible that you took a leap of faith and launched out on your own, personal sacrifices and financial risks be damned.

You were going to change the world.

Your vision evolved—clarifying over time, improving with age like a fine Cabernet Sauvignon. And, if you are a strategic type, you may have developed a laser-focused three-, five- or 10-year-plan to achieve your vision.

But, beware the misaligned client.

Misaligned clients are often highly profitable. They may pay their bills on time. And, they may even fawn with appreciation and respect for the work you deliver.

All the while, they’ll be derailing the company from achieving your vision.

In exchange for a profitable engagement, the misaligned client will divert your limited time, energy and resources from work that is actually aligned with your vision.

What is Client Alignment, Exactly?

As a business’s leader, you must ensure all aspects of its operations are aligned with your vision.

A vision is a set of ideas that describe a future state . . . The future is something that an organization must grapple with. Visions should provide a sense of aspiration, they should stretch imagination. —Defining Your Company’s Vision

A vision describes the type of work a company seeks to perform to achieve some positive change in the world.

The company’s core competencies—the services it’s good at delivering—should align with that vision.

For instance, if your vision was “to be the premier source for connecting data science talent to career opportunities,” you’d need to be skilled in sourcing data scientists. But, you wouldn’t need any expertise in sourcing accountants, Web developers, or human resource generalists.

If you took on a new client to help hire five accountants, this would be a misaligned client. It may be a very lucrative engagement—but how does it move you closer to achieving the vision stated above?

It doesn’t. It’s a distraction.

How to Spot Your Misaligned Clients

Listen, we’ve all been there.

In the struggle to grow our consulting or professional services businesses, we’ve all take on clients that weren’t quite right. They were an opportunity for quick profits or maybe to get our foot in the door somewhere.

Or, maybe our vision changed and we developed a new direction for the company. For instance, the market for data scientists dried up, forcing us to develop a new vision. But, we’re stuck with “legacy” Data Science clients that are now a distraction.

To spot misaligned clients, divide every client into one of two buckets:

• Aligned clients are those who receive either your current core services or your aspirational core services, if you’ve developed a new vision.
• Misaligned clients are those who distract you from achieving your vision, whether that means they’re receiving one-off services, they’re legacy clients, or they were a quick buck.

Dead-End Clients Offer Dead-End Relationships

What percentage of your best client leads come from referrals?

My guess is quite a few.

Referrals should represent your best source for strong, qualified leads. A client relationship that generates new leads, then, is more valuable than one that doesn’t, assuming all else is equal.

Here’s another question: Do you prefer to sell to an existing client or to a prospective client?

Again, assuming all else is equal, it should be more straightforward to sell follow-on work to an existing, reasonably satisfied client than sell new work to a prospective client.

Unlike an existing client, a prospective client must make a leap of faith to hire you.³

Companies can boost profits by almost 100% by retaining just 5%
more of their customers. —Zero Defects: Quality Comes to Services

Harvesting client referrals and expanding your footprint at existing clients is a bedrock growth strategy.

If an existing or prospective client is not likely to help grow your business through referrals or follow-on work, you must focus your time and energy on clients who will.

How to Identify Your Dead-End Clients

There are four ways existing clients can help you build your business:

1. Follow-on engagements: They offer you additional work.
2. Internal referrals: They refer you to another unit or manager within their organization.
3. External referrals: They refer you to a new prospect outside of their organization.
4. Testimonials: They provide a written, video or social media testimonial.

Almost any client can provide one or more of the above. But, if you don’t think a client can or will, it points to an issue in

• your client relationship,
• your service delivery,
• your business model, and/or
• your market.

Which of your clients or prospects are unlikely to provide referrals, follow-on work, or testimonials?

Figure out why they are a referral dead end. Dissatisfaction? Limited budget? Personality or company culture?

Once you determine the root cause, address it.

Unfortunately, some clients will never develop into referrers. So, if they are otherwise profitable clients, you may need to live with it. But ensure they are the exception rather than the rule.

3 Days to a Dreamy Client Portfolio

Some clients are a real pain.

But other clients are an outright threat to the health and success of your business.

We’ve looked at three types of nightmare client: The low-profit client, the misaligned client, and the dead-end client. You now have the tools to uncover them.

But having an awareness of what you should do is not enough.

Before the end of the day today, pull out your client list and sort them by how referenceable they are. Start with the bottom 20 percent—your likely dead ends—and come up with a plan to get a testimonial or, heaven forbid a referral.

Tomorrow, pull out that list again and this time sort it by how closely each engagement aligns with the work you want the company to be doing three years from now. Does that client engagement bring you closer to your vision or distract you from it?

Finally, two days from now, it is time to address the “P” word—Profits. This will take more work (but important work) to address.

To start, get a handle on how to track expenses per client moving forward. For instance, if you bill by the hour, find a time sheet app that assigns hours to each client (or even better, each specific client project).

Then, go back at least a month and make your best guess at properly allocate all your client-related expenses.

Now, sort the list of clients by gross profit.

Tackle each one whose gross profit falls below the minimum you’ve established. For each low-profit client, figure out how you raise their gross margin.

With the above techniques in place to consistently identify nightmare clients, it is next a matter of transitioning each client off the nightmare list.

You will then be positioned to pursue your vision for your company and turn disappointment into profits—while leaving behind the late nights at the office.

1. Gross margin is just gross profit converted into a percentage of revenue. As a percentage, it is easier to either compare across time periods or to industry averages. See Gross Margin.
2. Average gross margin varies widely from industry to industry, so do a little digging to see what is a realistic target.
3. If existing clients are not easier to sell to, drop everything else and fix this now.