Customer Profitability Analysis

Analysing and Managing Customer Profitability

• Relationships involve economic, social, and technical interactions creating value.
• Customer profitability analysis helps determine where to invest more or less based on value representation.

The Whale Curve

• A common belief is that all customers are profitable and the biggest customers are the most profitable.
• Customer profitability (CP) equals customer revenue minus customer-related costs.
• The Whale Curve is built by sorting customers from most to least profitable.
• Cumulative profit is calculated by adding each customer's profit to the profit of the previous ones.

L&P of Individual Customers

• A business can calculate customer profitability through a profit and loss report
• This can be calculated per customer.
• Considers revenue, costs of goods sold, gross profit, sales costs, administrative costs, and general overhead to determine EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

Methods to Analyse Customer's Profitability

• Contribution Margin is revenue minus variable costs.
• Overheads can be allocated either partially or totally.
• Allocation per average can be based by the number of clients or proportional to each client's revenue.
• Individual allocation of key costs occurs per activity and other costs per average.
• Total allocation per activity follows activity-based costing (ABC).

Analysing Customer Profitability

• Salespeople may focus on prices instead of costs when determining customer profitability
• Factors that impact the analysis of customer profitability are:
  • Business sustaining costs
  • Relationship costs
  • Service Costs
  • Costs of goods sold
• Consider the costs associated with products, selling, servicing, relationships, and business sustainability.

Hierarchy of Costs

• Product costs include costs of goods and direct costs of materials and packaging.
• Selling costs cover sales and marketing, customer acquisition costs, and advertising.
• Servicing costs involve distribution, administration, cost-to-serve, order processing, and shipping.
• Relationship costs include sales and marketing administration, account management, hospitality, and CRM systems.
• Business-sustaining costs cover administration, senior management, premises, and R&D.

Customer Lifetime Value

• Customer Lifetime Value (LTV) is the discounted profit that a client brings to a business.
• The calculation of Lifetime Value should consider all sources of customer value:
  • Potential base (cash flows from core relationship products)
  • Potential of growth (cash flows from cross and up-selling)
  • Potential of networking (cash flows from new relationships from WOM)
  • Potential of learning (cash flows from knowledge created in one relationship used in another).

Net Promoter Score

• Net Promoter Score (NPS) calculates customer's recommendation potential with the following scores:
  • 0-6 = Detractors: These are unsatisfied clients with negative testimonials.
  • 7-8 = Passives: Satisfied but indifferent clients who may be won over by competitors.
  • 9-10 = Promoters: Loyal clients who buy and recommend the brand.
• Favorable NPS impacts include:
  • above-average revenue growth
  • customers buy more and for longer
  • customers provide recommendations and feedback
• The Net Promoter Score should improve client relationships.

Improving Customer's Profitability

• Customize products, manage small/unpredictable orders, and address specification changes.
• Minimize excessive pre-sales and post-sales support.
• Review sales people's behavior and correct pricing errors.
• Manage inventory and payment terms.
• Adaptation has costs, including extra activities and complexity

Managing Customer Profitability

• Effective management strategies include:
  • Acquire
  • Develop and retain
  • Align (re-negotiate the value proposition)
  • Eliminate
• It is important to ask if you should consider something else besides the individual profitability of customers in a given period

What to Do with Non-Profitable Clients

• Explore all levers of value along the lifecycle through:
  • Effective deep, up and cross-selling
  • Reduce the cost of acquiring and serving clients
  • Increase customer lifetime
• Assess and reassess, and ask these questions:
  • Has the company misunderstood or mishandled customers?
  • Are the customers inclined to understand the company's position?
  • Can the customers and company find new ways to reap value from each other?
  • Might the customers be profitable for subsidiaries or other providers?
  • Is the value incompatibility between the customer's and company's beyond repair?
• Define a divestment strategy to develop strategies to acquire alternative clients.

Summary

• Customers contribute differently to a company's profitability.
• The analysis of this contribution should consider the entire relational cycle.
• Companies should explore all sources of value to increase customer profitability.
• Companies should use all value levers to reduce costs and increase direct and indirect revenues.
• Improving profitability may require eliminating non-profitable customers.