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customer profitability analysis

What is a customer?

❶To avoid entering into a debate over the difference between sales and service, we will define service as providing fulfillment of the sales promise to your customers.

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This means that there are 4 times as many customers in this lower-value group that consume much of your time and resources. By applying a cost factor to the sales of each customer, you can derive gross profit by customer.

For an even more sophisticated analysis, you can apply only your variable costs to the sales. Variable costs include not only direct product costs, but distribution and direct sales expenses and exclude all fixed costs, such as rent. By using only variable costs, you arrive at a contribution margin rather than a gross profit, which is more granular and revealing. You also need to allocate all of your promotional expenses, discounts, allowances, rebates and returns to the sales. The best of the best should receive your best service, best pricing and most nurturing.

If there are any customers with a negative margin, immediate steps must be taken to eliminate the negative amount because you are losing money on each and every sale. You could decrease deliveries or have minimum order quantities, increase pricing or send the customer to your competitor. Your sales force should be given the information on the low margin customers and either develop a plan for how to increase the margin or be directed to not sell to them anymore. This process should be performed each year in conjunction with a customer rating.

You should rate customers not only on profitability, but on your ability to utilize that customer in marketing campaigns prestige , referrals obtained from that customer, how quickly they pay their bills, and how easy they are to deal with. Reducing the number of low or negative margin customers and nurturing your best customers will provide enormous results in the form of better margins, less work for you and more quality. Product profitability also needs to be considered.

Without a disciplined analysis of the profitability of your existing client base it is very difficult to tell which types of customers you should be identifying for acquisition. All of the other target marketing information you presently use remains valid and useful: Having knowledge of customer profitability enables your company to manage and compensate the sales function for delivering value to the organization, rather than revenue or unit sales.

To avoid entering into a debate over the difference between sales and service, we will define service as providing fulfillment of the sales promise to your customers. Each industry is different in the way it provides service to customers but it is invariably an activity that provides value to your customers and cost to your organization.

One of the key issues in managing service is the allocation of costly resources to customer service rationally. For example, one Canadian energy services company established a policy of increasing the general level of reserved service "black-out" periods to create capacity.

This enabled reallocation of their trucks and technicians to more rapidly service their best customers without increasing overall cost. Understanding customer profitability offers a myriad of opportunities to you for managing the effectiveness of the resource allocation decisions you make concerning service.

In Canada, many industries have a bias towards providing all customers with equality of service levels. While this is one of the cultural attributes that makes us Canadian, it is absurd from a business perspective.

Not all customers offer the same value to our companies. Why then must we provide the same service to all customers? The answer may be complex in a regulated industry or one with a high public profile or public purpose, but in many for-profit corporations there is really no good reason that service differentiation cannot or should not be implemented. Service differentiation opens up the potential to treat your best customers better and to save money by reducing the levels of service provided to customers who contribute less to your company's well being.

Remember that there is a numbers game going on here: Altering service levels can take many forms. It may involve alterations in reward and recognition program premiums; call wait periods; access to privileged locations, times or content; face time with staff; fast-track processing or just about anything else you can think of that might be valuable to your preferred customers. The key to affecting service level decisions is knowing two things: Measuring customer profitability can help you to answer both of those questions with facts.

Product management is as necessary a discipline in a customer centric organization as it ever has been. Product managers have usually been blessed with access to some form of product profitability measurement which informs their management processes and thinking.

Consequently, we rarely see product managers emerging as the proponents of customer profitability in companies. We think this is unfortunate, as there is indeed opportunity lurking in this information for the product manager too. What the customer view brings to them is a deeper understanding of product interdependencies from a customer perspective.

Management of customer value demands that we also consider which of our customers are using the products or services we are making these decisions about.

Where are the opportunities to optimize loss leaders for our preferred customers? Where can we create an opportunity for holistic relationship pricing? How much can we afford to give as discounts and to whom? Where can we raise prices without risking our key customers? What are the implications for new product development? These are the kind of questions our product managers need to be considering. Operations management is largely concerned with optimizing processes to achieve efficiency and effectiveness.

This management challenge inevitably results in substantial change as new technologies and practices are adopted. One of the several insights that customer profitability can provide is to highlight which customers are affected by changes and the risk that the organization is taking by implementing operational changes. This is critical when evaluating risk and when communicating to customers about changes the company is implementing.

Another important way that customer profitability can be used in operations is in the evaluation of which processes and procedures are adding value to the company. For example, processes which involve few of the higher end customers have lower value than those that support large numbers of high end customers.

Ultimately operations processes can and should be measured in relation to customers and customer value. In my years as a Financial Controller I was always amused by the budget setting process.

It seemed to be a tug-of-war between the conservative projections of management and the Board which always demanded a far higher return. In the end, I always found the resultant plans to be somewhat dissatisfying, sort of like a cease fire called because we ran out of time for the war. Did we have the kind of information we really needed? It also gives a much clearer direction to management than traditional planning measures.

In our experience, customer profitability information has not yet taken on this level of strategic use in finance. This may be because the measures are relatively new, and adoption takes time. Nonetheless we foresee that this is where business planning is inevitably going to head, because the customer really is the central measurement basis for your company.

Your company's present value is the sum of the present values of your customers. Your company's potential value is the sum of the potential value of your customers plus a factor for net new business. In many business acquisitions these are now taken into account as critical factors in the valuation process. Knowing what these values are is central to understanding the real value of your business franchise.

Customer profitability measurement is challenging to implement; it draws into question our understanding of who our customers are and how we make profit. It can add powerful insights throughout your business, helping to focus decision making energies on doing what is right for your customers and your shareholders at the same time.

In a customer-centric organization, measuring customer profitability has become a business imperative: Our sense is that you can not afford to manage without these facts as you make decisions concerning the sales, service, product management, operations and finance functions of your business. Executive Events Webinars Awards.

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What is profitability?

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In both instances, the companies performed a customer profitability analysis to determine if certain groups were causing more harm than good. In these cases, the old adage, the customer is always right certainly does not apply.

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customer profitability analysis - noun analysis of the revenues and costs associated with particular customers.

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Aug 22,  · A customer profitability analysis is an evaluation process that focuses on assigning costs and revenues to segments of the customer base. The customer profitability definition 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”.

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Topic Gateway Series Customer profitability analysis 8 2. Managing customer value Analysing customer profitability has evolved into managing the overall value of customers. CPA now includes analysing customer lifetime value and impact, as well as managing profitability through analysis of customer segments and margins. The first step in analyzing customer profitability is to sort your annual sales by customer in descending order. You will notice that the top 20% of customers generate 80% of your sales. Therefore, 80% of your customers only account for 20% of your sales.