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Introduction
Customer profitability analysis (CPA) helps companies to better understand
customer service activities and cost drivers, and to determine the
profitability of each customer or customer category. Customer service
encompasses all activities related to completing a sale and satisfying the
customer, including advertising, promotion, delivery, billing, collections,
service calls, inquiries, and other customer services. CPA helps managers to:
present profitable new products and services;
analyse profitable customers;
administer each customers costs-to-serve;
suspend unprofitable products, services, or customers;
change a customers purchase mix, typically aiming to sell higher
margin products and service lines;
deal with discounts to achieve more sales with lower operating costs;
and
select the types of after-sales services to provide for customers.
CPA can be used to work out which customers comprise the top 20% (and
the bottom 2%).
It can also be used to help companies to understand:
how dependent they are on the most profitable customers
what proportion of resources are used for different customers
the full cost of servicing a customer including advertising, service and
returns
which customers are targeted by competitors.
Now, while many customers may not be generating a positive net margin,
most will be making some contribution to overheads. So it is detrimental to
overall profitability to fire customers unless you have first identified whole
tranches of indirect expense that can be successfully eradicated as a result.
A better alternative is to implement a raft of incremental improvements to
increase gross margins, and make it cheaper to do business with the
customers you already have, rather than going out and winning new ones. So
here is my list of the five key things you can learn from your
customer profitability analysis that you can put into action:
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. Dont 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. 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. Its key to then in turn empower reps to quickly
ameliorate any occasional service failures with credits and free product to
keep these customers happy.
3. 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.
4. 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.
5. 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 fulfillment.
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, Ive 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.
general be notice to the firm. These will also creating new opportunities for
the firm in these three areas below.
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3. Use ABC to
2. Revenue
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4. Analyze the
Analysis
Implementation
5. Develop strategies
to maximize profits
from profitable
customers and reduce
or eliminate less
profitable or nonprofitable customers
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significant, some or all of these costs may have to be removed from product
cost and, instead, be directed or assigned on a customer basis
Customer-specific Costs
Customer-specific costs are those costs that are driven primarily by the
needs or demands of a particular customer. Besides the costs identified
above which may have been incorrectly classified as product costs, they
include many of the costs which are usually referred to as Selling, General &
Administrative costs. However, they are viewed from the customers
perspective and the way in which they add value to the customer. These
would include sales, marketing, distribution, advertising, legal and executive
expenses.
Asset Opportunity Costs
Asset opportunity costs are those costs that can be assigned to customers
based on the assets of the company that a particular customer consumes.
They could include working capital such as inventory and accounts
receivable as well as fixed assets such as machinery &equipment.
Advantages of CPA
Improved profitability by eliminating non-profitable customers and
maximising sales or services to profitable customers.
An understanding of the true costs of each customer segment, including
taking into account non-production costs when determining profitability. Nonproduction costs can sometimes be more significant than production costs.
It provides a method of identifying customer groups who are of lifetime
value to the company, and who are worth retaining or protecting.
Improved strategic decision making by providing useful information for
customer related decisions, including pricing, discounting and marketing
decisions.
Disadvantages of CPA
Companies may not have the data capture systems to produce an accurate
estimation of customer segmental revenues and costs.
There may be practical difficulties in calculating costs attributable to each
segment. Implementing ABC is often challenging for many companies.
CPA may overlook the combinations of products or services purchased by
customers. Customer profitability depends on the mix of products or services
bought. The danger is that the analysis will be used on specific
underperforming products or services, and will overlook the impact of sales
of other products to the customer.
Annual profitability may not be representative of lifetime value. The costs
of attracting and retaining a customer should be compared with the lifetime
earnings and not just with the customers annual earnings. For example, Taco
Bell sells tacos at less than $1 each. However, the firm has estimated that a
loyal repeat customer generates up to $11,000 over their lifetime [Kotler,
1997].
have
been
overcome
due
to
recent
Key developments
1. Advances in information technology:
This has allowed companies to improve the quality and quantity of
information concerning customer profitability, including information on
revenue, costs, retention and lifetime value. Many companies have
sophisticated customer profitability models and customer databases. These
can be designed for any type of business and to accommodate different
customer characteristics. Data can be aggregated by size of customer, size
of order, service complexity, post sale service requirements, location or other
factors. Information technology can provide detailed information and analysis
on individual customers or groups of customers.
2. Managing customer value
Analyzing customer profitability has evolved into managing the overall value
of customers. CPA now includes analyzing customer lifetime value and
impact, as well as managing profitability through analysis of customer
segments and margins. Customer lifetime value looks at the profitability of
the customer over their lifetime. Customers have an impact on other
customers, company employees and other groups through their transactions
and communications. For example, they can refer other customers to
company offerings.
Case studies
An insurance company, A-Insure Limited, decided to use CPA to identify
profitable and non-profitable customers after it grew concerned about the
poor financial performance of one of its policy options. A-Insure collected
customer data through original policy proposal forms which were stored
electronically in a customer database. It was able to conduct a complex cross
correlation between known cost drivers and the demographic and other
characteristics of policy holders. The cost drivers were:
commission payments to financial advisers who sold the policy
early surrender of the policy by the policy holder
Information technology
Developing customer databases has improved decision-making regarding the
cost of keeping existing customers. Customer profitability models can be
designed for any type of business and for different customer characteristics.
Data can be aggregated by size of customer, size of order, complexity of
service, post-sale requirements, delivery distance, etc. The information
technology is currently available to provide detailed information and analysis
on individual customers or groups of customers. First Union and many of the
other banks discussed here have developed profitability models from their
large databases. Customer service representatives can then obtain instant
customer profitability rankings from the computer.
Barriers to implementation
People often feel threatened by change, do not understand it, and are
opposed to it within a company. Commission salespersons will try to protect
customers even though they may not be profitable to the company.
Customer profitability analysis can be a large undertaking for an organisation
in terms of the resources used and the costs to complete the initiative.
Barriers to implementation can include:
convincing management that potential organisational improvements justify
the resource allocation;
obtaining the significant required resources that include information
technology, equipment, and staff for analysis and preparation;
changing the sales incentive system to reward customer profitability rather
than sales volume;
obtaining buy-in from employees within the company who are often
reluctant to change; and
training employees in the use of customer profitability analysis and its
measurement and rewards.
However, management must be sensitive to required change within the
organisation and be sure that employees are included in the decision and
change processes. Sears did an excellent job of change implementation.
While the new Sears vision began with top management, the implementation
of the changes began with changing employee attitudes, obtaining employee
buy-in, and increasing training costs for new and existing employees. The
Conclusion
Customer profitability analysis deals with sales revenues and costs
generated by customers. Managers are interested in forward-looking
analyses of customer profitability. Prospective CPA calculates the net present
value of future expected revenues and the costs associated with serving
customers over the entire future customer lives. To estimate future costs and
revenues, a retrospective analysis of customer profitability is valuable and
essential. Managers must constantly make decisions that involve trade-offs.
They need to determine how much to invest in human resources and in
customers. To make these decisions they need to analyze the returns that
are likely from those investments, the costs of those investments, and the
managerial incentives in place to make those investments. This guideline
offers an improved understanding of the analysis of customer profitability in
order to assist managers in the allocation of corporate resources.
Bibliography
This term paper is prepare by the participation of all group members and the
important class lecture of our honorable course teacher and also have some
books and websites which are given below for further query.
W. Bigg :cost accounting
Philip kotler: Principle of marketing
Cooper, Robin, and Robert S. Kaplan. 1991. Profit priorities from
activity-based costing.
The Design of Cost Management Systems. Upper Saddle River, NJ:
Prentice Hall, Inc.
Foster, George, and Mahendra Gupta. 1994. Marketing, cost
management and management accounting. Journal of Management
Accounting Research (Fall).
Fornell, Claes, Michael J. Ryan, and Robert A. Westbrook. 1990.
Customer satisfaction: The key to customer retention. MOBIUS
(Summer): 14-17.
GOOD PRACTICE GUIDELINE MARCH 2002 (FACULTY OF FINANCE AND
MANAGEMENT)
Customer Profitability Analysis in Accounting (Relevant to PBE Paper II
Management Accounting and Finance) Dr. Fong Chun Cheong, Steve,
School of Business, Macao Polytechnic Institute