Customer profitability analysis is best conducted with a technique known as Activity based costing or ABC analysis. Customer profitability analysis helps the company understand the net profit coming from each customer which can be calculated by revenue less costs. These costs are not only manufacturing and distribution costs but also sales costs, marketing costs, services cost and any other related costs which have to be undertaken to service the customer. Many people today don’t know the meaning of customers profitability analysis. it is the profit the firm makes from serving a customer or customer group over a specified period of time, specifically the difference between the revenues earned from and the costs associated with the customer relationship in a specified period.
It is found that with customer profitability analysis, the firm can correctly classify customers and also find out which of the customers it needs to hold on to and acquire more of the same type, and which customers it needs to let go of. Several times, companies find out that there are customers which they should have left altogether as the profitability from these customers is minimum and expenses are more.
Issues With Customer Profitability
It seems self evident that customer profitability analysis is a useful approach, so why isn’t it in common use?
This is what I think is the reason:
When you’re not certain about how to capture and portray the figures.
A lack of skills- One of the challenges associated with customer profitability analysis is that it calls for hybrid skills – forensic accountancy grafted on to marketing or CRM. Few CEOs or financial directors ask for this kind of information and marketers are notoriously innumerate.
Accurate customer information can be difficult to get hold of, so any results are open to question.
Identifying contributory costs calls for cross company collaboration to build a complete picture of the customer. There is often resistance to such an exercise.
In business to consumer markets in particular the scale of the exercise is often too daunting.
A lack of a recognised method and doubt about the results.
That customer profitability analysis provides an historic picture and fails to take into account the future potential profitability of a customer.
Over allocation or under allocation of costs based on proxies, in the absence of accurate data.
Even if a reasonable picture is developed, there is concern about what to do with the results.
Hence, another hindrance in calculating customer profitability analysis is to calculate cost. Calculating cost per customer becomes difficult especially in a service environment where manpower as well as time also has a cost factor associated with it. Time spent with each customer is different and therefore the cost is different. Furthermore there are several non customer related costs too such as the cost of lost customers. If the firm ignores these costs then the final cost will be not be the right figure thereby affecting the overall customer profitability analysis. The customers will be shown more profitable than they actually are.
If you are wondering what you need customer profitability analysis for and what you stand to gain or learn. Here are some reasons why you need customer profitability analysis
1. Focus your acquisition spend
Now you know exactly who your most profitable customers are, make sure the marketing strategy is based on winning more of them. Don’t waste big budget dollars retaining unprofitable customers or making it difficult for profitable customers to do business with you. That is not to say that every customer needs to be profitable. Having a few unprofitable key accounts that make a significant contribution to overheads may make sound commercial sense.
2. Rework your discounting policy
Knowing how net profitability varies with customer size gives you important insights that once paired with data about product profitability will help you formulate a commercially driven discounting policy. At the same time, you are likely to uncover instances where unprofitable customers enjoy special discounts that were based on projected volumes that were never achieved. In addition, business to business customers will be enjoying volume related discounts, retrospective rebates and early settlement discounts, all of which need analyzing in considerable detail.
3. Target your retention activity
Likewise, make sure retention activity is not wasted hanging on to loss-making customers. Also ensure that your customer contact teams are aware of which group of customers are the most valuable to the business. It’s key to then in turn empower reps to quickly ameliorate any occasional service failures with credits and free product to keep these customers happy.
4. Plug the holes in your terms of business
Many customers fail to generate any profit because they only place small orders where the contribution fails to meet the cost of order processing and fulfilment. Reviewing minimum order quantities can do a lot to keep the costs of doing business with a customer better aligned with the amount of business they give us. But, I’ve always been an advocate of subtly incentivizing customers either to change their behavior. This can include encouraging the use of lower cost, self-service channels, or incentivizing them to buy more product by making attractive bundles or by having a minimum shipping charge – or free delivery over a certain order value.
5. Revisit your channel strategy
One of the key reasons customers are unprofitable is because the costs of doing business with them is out of step with their potential for profit. This can be anything from sales people calling too frequently on customers with limited potential or even telephone selling to customers who should really be ordering online. Moving such customers to self-service sales and service channels results in cost savings. That savings can be used as introductory discounts to smooth the transition to this new service model, and reinforce the behavior.
You can implement customer profitability analysis by following this steps
Step 1: Selection of active customers
Step 2: Design of customer profitability model
Step 3: Customer profitability calculation
Step 4: Interpretation of results
Step 5: Attune strategies and programs
Step 6: Establish infrastructure
By using customer profitability analysis, firms can determine the profit contribution of customer segments and/or individual customers and more also customer profitability analysis will bring a wealth of new information to the firm that uses it for the first time. As such, customer profitability analysis is highly valuable by itself. At this point, there is little evidence of its widespread use and actual implementation in industrial firms. In an era of increased attention for CRM and customer loyalty, customer profitability analysis may well be the much-needed backbone for such efforts.
My advice: knowing customer profit is an important step in understanding which customer relationships are better than others. Often, the firm will find that some customer relationships are unprofitable. The firm may be better off (more profitable) without these customers. At the other end, the firm will identify its most profitable customers and be in a position to take steps to ensure the continuation of these most profitable relationships. However, abandoning customers is a sensitive practice, and a business should always consider the public relations consequences of such actions.[