Customer Profitability Analysis

CUSTOMER PROFITABILITY ANALYSIS

By :

Presented

Flow of Presentation  Definition

Of CPA

 CRM  Importance

of CPA in CRM  A Hypothetical Situation  Determining Customer Profitability  The CPA Process  From ABC to CPA  Conclusion

Definition 

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Analysis that assigns revenues and costs to major customers or groups of customers rather than to organizational units, products, or other objects. The results may direct organizational resources towards more profitable uses. It is an application of segmented reporting in which a customer group is treated as a segment. It is especially helpful when combined with an activity-based costing approach that determines which activities are performed for each group and assigns costs based on appropriate drivers. Example : Activities, their drivers, and their costs may be classified as order level, customer level, channel level, market level, or enterprise level.

Contd… 

In other words, Customer profitability analysis combines analysis of manufacturing costs based on customer requirements with analysis of the costs of serving customers through different channels.

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It takes as its starting premise, the viewpoint that the economic value of customers varies, and that the variation is due to a combination of economic forces and behaviors on the customer side as well as within the

CRM 

CRM (Customer Relationship Management) is an information industry term for methodologies, software, and usually Internet capabilities that help an enterprise manage customer relationships in an organized way.

Importance of CPA in CRM 

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Unless you are trying to penetrate new markets or are operating a loss-leader strategy, most of your business transactions should be profitable. It would indeed be foolish to sell your products for less than it costs you to produce and market them. CRM, however, is not about product profitability but rather the development of relationships with your customers in order to meet their needs and make a profit overall. The challenge of CPA is, therefore, the tracing of both revenues and costs back to each individual customer in order to evaluate their profitability.

A HYPOTHETICAL SITUATION 

Now, Consider two different customers of a fictitious company. They both have purchased the same volume for total revenues of £5,000 each. Gross margin for the company on each transaction is £1,000.

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However, while the first customer has made no special product or process requests, customer 2 has required that the product be customised with special overprinting on the packaging and delivered just in time to three different sites. In addition, he has asked the company to provide special point of sale promotional materials, special sale or return conditions and a discount.

Contd…  These

specific requirements have meant that the sales person responsible for that account has had to spend twice as much time negotiating these terms. Taking all these additional costs into account, the margin the company makes on customer 2 is only £250.  Thus, All things being equal, customer 1 is four times more

Determining Customer Profitability Customer Revenue  Revenue is generally the most straightforward category to determine. Companies usually have information that captures sales/revenue associated with specific customers.  Other information needed may include customer discounts, rebates and other deductions.

Contd… 

Customer Costs Customer costs are calculated the same way as activity costs are calculated. Each activity that is mapped to a customer brings along an associated activity cost. The accumulation of those activity costs determines the customer cost. As with resource costs, the activity cost mapped to a customer is based upon the value of that driver as a percentage of the total drivers

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Example : Consider the mapping of the activity “Provide Customer Support over the Telephone,” which has a cost of $5,000,000 to customer A and customer B.

Contd…  Customer A receives 1500 minutes of

support, while customer B receives 3500 minutes of support during the same period.

 In this example, 30% (1500/5000) of the

$5,000,000 will go to customer A, and 70% (3500/5000) of the $5,000,000 will go to customer B. This means that you spent $1,500,000 in this period to provide customer support over the telephone to customer A.

The CPA process Start with the following data: Revenues per customer (including discounts or rebates, sales commissions, or credit notes); Total business unit costs, especially overheads.  The CPA process then takes four steps.

CONTD… 

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Step 1 For each customer subtract their direct costs (cost of goods or cost of sales) in order to identify their contribution margin. Step 2 Next, understand what you do to meet your customers’ needs i.e. map the various activities that go into serving them. The best way to do this is to develop a simple process flow diagram representing customer interactions and identifying where the cost elements lie. At this stage it might be useful for you to map your customers’ activity cycle and develop some form of graphical checklist . Additionally, the sequence of customer interactions might vary depending on the nature of your business.

CONTD… 

At this stage, using estimates is acceptable. Much of the analysis becomes easier once you have gained a clear understanding of your basic customer interaction processes and how many customers you have.

Step 3  For each cost group (sales force, call centre, etc.) identify what activities drive costs. Begin by allocating those costs that are simple to categorize and that you can easily relate to specific activities. Use your judgment to allocate those costs that are not as easily traced.

CONTD…  Step

4

 Finally,

just subtract the overhead costs that you have just computed in step 3 from the contribution margin of step 1.

From ABC to CPA  CPA

relates to activity-based costing by linking operational activities (and their costs) with individual customers. Starting with ABC will therefore, provide you with key insights into a customer’s profitability while going some way in explaining why different customers have

CONTD… 

Conventional Costing Simplistic allocation of costs

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Costs --Consumed by-- Products

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Allocation: Costs are allocated to products based on assumed linkages or convenient alternatives such as direct labour hours

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Activity-Based Costing Traces costs based on cause and effect Costs-- Consumed by Activities—Consumed by products

CONTD… Resource

Cost Drivers: Costs are assigned in activities based on usage patterns Activity

Cost Drivers: Activity Costs are assigned to products based on usage patterns

Conclusion 

Customer cost and customer profitability is critical for a company today. Knowing your total costs for particular processes and activities allows you to focus on reducing and controlling them. Knowing costs for a specific customer allows you to reduce, chang or charge for activities/services provided to them.

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The determination of customer costs and profitability should be performed using activity based costing techniques. Although it

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CONTD…  Although

many companies do not have customer cost and profitability systems, a growing number are beginning to develop them and it is imperative that you develop the information before your competitors do.

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