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-: Customer profitability analysis
uses activity-based costing techniques
to assign costs to individual customers or customer groups.
In this case, the customer is the cost object
instead of a product or service.
We also keep in mind the differences in revenues
which also impact profitability
and can vary depending on the customer or customer group.
Usually customers will be split into customer groups
based on service levels,
or into segments based on buying behaviours or preferences.
The reason we undertake customer profitability analysis
is to identify profitable customers
so we can focus on retaining them,
identify low-profit or lost customers
so we can work out how to fix this,
and identify the types of customers
that we should focus on to maximise profitability.
Generally, you will find that customers
that have a high cost to serve will yield low profits
unless they pay top prices for this.
Customers that have lower cost to serve
will yield better net margins,
and these will increase
as the revenues from the customer can be increased
depending on the customer's sensitivity to price.
We need to focus on the long-term costs and benefits
from a customer relationship,
as sometimes a low margin might be okay
if the customer will be locked in
for a significant period of time
and yield long-term returns
or provides other, non-financial benefits.
Knowing how much it costs
to service customers in particular ways
can be an extremely beneficial piece of information
for strategic decision-making.
Remember that customer profitability analysis
is another tool in your toolbox
for understanding and analysing your organisation,
which then goes into working out your strategy
to increase your competitive edge
and enhance or create additional value.
Some examples of customer-driven activities
that can cause cost differences include
marketing and selling,
relating to things such as marketing channels.
Some customers might require more love and attention,
whereas others will buy
simply based on the price or features.
Order entry costs.
This is related to the amount of time
spent processing orders.
Many small orders versus less larger orders
will cause order processing costs to be higher,
particularly as a proportion of the sales dollars.
Loading and shipping of customer orders, invoicing,
collecting sales revenues,
technical and administrative support,
and after-sales service.
There is a hierarchy that is worth keeping in mind
when looking at customer activity costs.
This is order level activities,
such as processing orders, invoicing, packing,
delivery and collecting money.
Customer level activities,
such as acquiring and maintaining customers,
sales calls, technical support and sending out catalogues.
And market level activities, based on classes of customer.
This includes things such as advertising,
market research and trade shows.
And we have facility level activities.
These are not driven by customers,
and should not be allocated
for the purposes of customer profitability analysis
for decision-making.
These include things such as rent, power and water.
The analysis process is,
one, identify customers, either individuals or groups.
Two, measure revenues from each customer or group.
Three, measure full service costs for each.
Four, determine profitability.
Five, evaluate profitability, and six, take action.
There are some things to be aware of, as with everything.
Allocation of some costs,
for example advertising, can be arbitrary,
and which customers this actually impacts upon
may be difficult to determine.
Treatment of unavoidable or committed costs, if ignored
for the purposes of customer profitability analysis,
you may be understating the true costs
if they are actually related.
For example, things like the sales manager's salary,
so they need to be either allocated evenly,
or noted as being excluded.