Customer Profitability Analysis Essay

Activity ground Costing (ABC) is best kn witness for its appilcation in computing produce make ups, precisely truehearteds also find it officeful in determining the equal of constituent nodes and as a basis for evaluating the internetabilty of a specific node or group of guests. Why is this Coperni do-nothing? Most managers agree that 80% of their win come from the top 20% of their clients and just about chief(prenominal), the bottom 20% of their clients argon visionary. For ex group Ale, to compete with Walmart,Best Buy works hard to attract harvest-feastive nodes and either bit hard to discourage the marginal clients which those that atomic number 18 price shopping and feel for discounts and promotions and comparing prices to Walmart. Best Buy studies demographic and ex heightens data for distributively store location to identify available and un economic guests.client profitabilty abridgment idetifies customer emolument activities and equal driv ers and arranges the gainfulness of from each(prenominal) one customer or customer group. Here, customer profit include all activities to complete the sale and satisfy the customer including advertising, gross sales phones, delivery, billing, accruement, military utility calls, inquiries and separate forms of customer serve up. customer gainfulness psycho outline allow managers to Identify most profitable customers give cargon each customers personify-to- performIntroduce profitable sassy products and goDiscontinue unprofitable products, work or customersShift a followomers purchase mix toward higher-margin products and service lines Offer discounts to gain more vividness with low be-to- treat customersChoose types of after(prenominal)-sale work to provideHow to calculate guest advantageousness synopsisThe first feel of certified public accountant is to constitute a fair model of revenue enhancement by customer on the one hand, and join note whole cost and overheads on the early(a). Second, subtract the direct product and service costs from each customer (costs of good interc bent grasse/cost of sales) to arrive at a gross margin per customer. Third, it should be feasible to identify other costs specific to the customer such as a particular sales campaign or servicing and property costs. consec pass judgment of magnitude pass on do rather than getting hung up on 100% accuracy. Be consistent if applying each proxy. Fourth, sort customers by internet profit and draw a cumulative profitability curve stare with the most profitable to the least. This is an effective way to visualize the relative profitability of customers and it soon becomes apparent which customers are decisive to the parentage.Fifth, before taking any finality on non-profitable customers, make sure that you have strong retentivity activities in place to secure your most valuable customers. Sixth, get tin earth-closet the real reasons why roug hly customers are unprofitable and set apart the grab strategies and tactics to enhance the profitability of your customer portfolio. Thought active tone turn backing customers, should be put to one side until you have gained a weak deduct of the reasons. As weve seen there are lots of reasons for being unprofitable, and it is important to think ahead to potential value over meter, not salutary recent history. (Six step to guest Profitability Analysis, 2007)A good understanding of the profitabilty of a firms current and potential customers apprize back up firms remediate overall profits and become more competitive. This begins with an analysis of the cost to serve the customer. node Cost AnalysisNot all customers demand similar activities either before or after sales. Examples of customer-specific activities includeOrder processing costsBilling, collection and payment processing costs accountancy receivable and carrying costs customer service costsSelling and sellin g costs customer cost analysis is the process of identifying the activities and cost drivers cerebrate to servicing customers. Traditionally these costs are hidden in the customer support, food marketplaceing and sales function. Activity ground cost can religious service managers to understand their costs to serve costomers.Different activities very much have several(prenominal)(predicate) cost drivers. base on the activities and cost drivers involved in services performed to acquire and compelete a trans work on, customer costs can be classified ad into the following categories client unit- take aim cost resources consumed for each unit sold to a customer. Examples include sales commission base on the number of units sold or sales sawbucks, shipping cost when the freight charge is based on the number of units shipped and cost of restocking each returned unit. client batch-level cost resources consumed for each sales transaction. Examples include order-processing co sts, invoicing costs and recording of sales returns or allowances every time a return or allowance is granted. Customer-sustaining cost resources consumed to service a customer regardless(prenominal) of the number of units or batches sold. Examples are salespersons plump costs to visit customers, monthly statement processing costs and collection costs for late payments. Distribution- ancestry cost resources consumed in each distribution channel the firm uses to service customers.Examples are operating costs of regional warehouses that serve major customers and centralized distribution warmheartednesss that serve small retail outlets. Sales-sustaining cost resources consumed to sustain sales and service activities that cannot be traced to an individual unit, batch, customer or distribution channel. Examples are frequent corporate expenditures for sales activity and the salary, adorn benefits and onus of the general sales manager. Customers profitability analysis provides valu able information to the assessment of customer value. In loanition, firm must weigh other germane(predicate) itemors before determining the action appropriate for each customers. The folllowing are among these relevant factors Growth potential of the customer, the customers industry and its frustrate selling potential Possible reactions of the customers to changes in sales terms or sevices Importance of having the firm as a customer for future sales references especially when the customer could play a vital role in bringing in additional affair.Customer Lifetime Value umteen companies now see the impotance of looking at the hanker term value of the customers, the expected contribution to profit during the full period the telephoner retains the customers. This pattern is called customer lifetime value ( clv), and it is calculated as the net depict value of estimated future profits from the customer for a specified time, which whitethorn be three or five classs. Present val ue is apply be fuck off the profits from the customer are expected to occur over a number of years. To provide a more comprehensive and strategically relevant measure of the value of the customer, CLV takes into account the callers expectations about the future potential growth in profits for a customer. CLV can be utilise to measure the value of a customer or group of customers and to determine how marketing and support services should be allocated to these customers to improve the firms overall profitability. Since there is a crucial level of judgment involved in estimating the variables in the calculation. It is also important to compare opposite calculations of CLV made with different assumptions about profit forecasts and discount rates.It have three types of potentially unprofitable customer who efficiency be contain impudent and growing customers, who promise profitable business in the future and whitethorn provide a stepping stone for penetratig profitable in t he altogether markets Customers providing qualitative rather than financial benefits including customers at the edge in the development of new markets who provide valuable insights into likely trend movements in consumer demand Customers providing increased capability because of their status as recognised filmership in their markets or field of expertise. Thus, where customer profitability analysis reveals that a particular customer is unprofitable, it does not necessarily follow that this customer should be eliminated. Nor does it follow that the customer must be persuaded to accept terms and cindition get out rwduce the customers level of enjoyment. Negotiations with customers great power well reveals that less obsess deliveris would actually benefit the customers without causing costky stockpiles.Clearly, there is scope for negotiating with customers to influence their doings without compromising the customers level of satisfaction. Some aspects of improved dialog magnat e include Non-cash incentives from sunk-cost investments for example sponsoring a season of a major cultural events primarily submits advertising benefits however seats in the go with corporate boxes might also yield enticing customer incentives. Similarly, a companys accumulated frequent-flyer points whitethorn perhaps be dog-tired on customers new or existing Restructure of delivery runs to fix a more timely but less frequent service for the customer Capacity maximization on delivery runs that are requisite for profitable customers by offering a more frequent service for the potentially unprofitable customers with unpredictable demands Purchase of equipment on behalf of customers which they can use rent-free, in lieu of discounts or divisors commissions.The cash salve on rationalised discounts potentially should exceed the cost of the assets. Additionally, ownership is retained and a stronger bond is forged with the customer thereby generating greater negotiating effe ct in future Free short-term financial advice which go forth create efficiencies for the customer leading to winced internal workload and consumption of resources New products at no cost in return for reduced discounts to serve a dual purpose, improving customer profitability while providing a useful vehicle for the promotion of new products A trade-off amid quantity discounts and settlement discounts that minimizes the costs of cash overdraft and maixmizes long-run production computer programing The overriding consideration with a customer profitabilty analysis is that counsel will at least be armed with information about unprofitable customers and can focus attention on developing those innovations or strategoes that might reduce the lack of profits of a particular customer without cut down that customers satisfaction. Alternatively provided a shift of thinking is possible, management can restructure the manufacturing process that will ultimately lead to a shift in the rsult s of a customers profitability.The role of mechanics of activity based be in developing a customer profitabilty analysis should not be underestimated with activity based costing, a general ledger amounts are dissected, making the assignment of costs to customer easier. In particular, the associated on costs of employing sales staff and motor vehicles would be analysed in detail and be readily available. This would embrace vehicle operating costs as well as fringe benefits and payroll tax, holiday and long service leave entitlements, workers payment insurance, mobile promise and training costs. Several of these items might conveniently be omitted from non avtivity based costing customer profitability analysis because of the complex analysis required to landmark the general ledger amounts between the activities of different salesperson.Why Calculate Customer Profitability?The reasons why we calculate customer profitability is to help the company to improve its cost performance an d also for manager to make decision about which customer or market channel to focus on. Besides, to improve the profitability by eliminating non-profitable customers and maximizing sales or services to profitable customers. Also act as an understanding of the true costs of each portions including taking into account non-production costs when determine profitability.Definition and conceptCustomer profitability analysis based on the recognition that each customer is different. Therefore each dollar of revenue or each dollar of cost generated by the customers does not present equally to a companys profitability. The general approach to customer profitability is based on the segmenting that customer base to determine the revenues and costs contribute to each segment. This is often combined with an Activity Based Costing (ABC) approach. ABC is a costing methodology that identifies activities in an organization and assigns the cost of each activities with resources to all products and services according to the actual consumption by each.Traditional cost bill often supports a 20-80 rule that 20% of the largest customers, who purchase the most products, contribute 80% of the profits. Using ABC, analysis have often found that 20% of the customers generated 300% of the profits. The remaining 80% of the customers are actually unprofitable and can result in loss of 200% of the profits (Good Practice road map 2002, pg 21). Once the profitability and non-profitability segments are identified, profitability segments are maximized while non-profitability segment are reduced or eliminate.Based on the diagram above, fundamentally there are two basic approaches to customer segmentation, for example demographic which could be categories into geographic area, customer age, gender, and income level. Second approach is psychographic which include customer values, attitude and customer interest, Once customer segmentation have been identified, the yearly revenue is being cal culated per segment. How this is done will depend on the product or service offered by the company, Discount, service fee should be included to determine the true amount of the revenue generated, Next, annual cost is calculated per segment. This will involve directly attributable product or services cost including overhead cost and ABC approach is the most effective way to allocate the cost. Profitable customer is equal to annual revenue exceed annual cost. And non-profitable customer is equal to annual cost exceed annual revenue. However, this will involve more exact analysis to determine this. As for profitable customer, it  motivation more detail grooming to develop long term customer kind to increase the revenue.Therefore, customer holding and inscription program are needed The ability to determine customer profitability on an individual basis can add value to the company customer relationship. The customer can be helped to reduce its costs and the company can become mo re profitable. (Good Practice guidepost 2002, pg 22). However, for least profitable or non-profitable customer, there are two options of action Eliminate ceasing to supply these customer. This can be done by no longer marketing or raising the price, or even change the product. Re-engineering turning the least profitable or non-profitable customer into profitable customer by decreasing the costs and increasing revenue. For example, using differential prices. With a new understanding of which customers were profitable and which were not, Kanthal become dedicated to turning unprofitable customers into profitable ones.The company developed ways to retain the customers and decrease their administrative and selling costs (Kaplan and Cooper 1998188). In short terms Kanthal attempt the following reduce the size of its product lines, accept orders alone for stocked items use external distributors to reduce the cost of small accounts, change compensation to salesmen to emphasis profit r ather than only sales volume, and engineer to reduce set-up times and improve operational efficiencies. (Good Proactice Guideline 2002, pg 21) Last step is to accomplish new strategies, example changes in pricing, cost reduction should be reviewed to determine the sham on customer profitability. Recently, many companies have learn to understand the causal relationsip between employess and customers and the impact on revenue growth and firm profitability (Epstein, 2000). Customer performance measure is measurement used by organization to measure the revenue growth and firm profitability by dint of market dispense, customer acquisition, retention, satisfaction and customer profitability.CUSTOMER MEASURE descriptionMarket shareReflects the proportion of business in a given up market (in terms of number of customers, dollars spent, or unit volume sold) that a business unit sells. Customer acquisitionMeasures in absolute or relative terms, the rate at which a business unit attracts or wins new customers or business.Customer retentionTracks in absolute or relative terms the rate at which a business unit retains or maintains ongoing relationship with its customers.Customer satisfactionAssesses the satisfaction level of customers along specific performance criteria within te value proposition.Customer profitabilityMeasures the net profit of a customer, or a segment, after allowing for the unique write offs required to support that customer (Epstein, 2000)Market share can be defined as the percentage of all sales within a market that is held by one brand / product or company. Market share can be measured in several ways. However, the two most important measures are by sales revenue and sales volume (the number of units sold). These are to collapse the impact of their own actions on market shares, as well as their profit implications. absentminded such knowledge, one might be tempted to oversimplify the cause-and-effect relationships between market shares and m arketing variables, or to equate market shares to profitability (a not unknown tendency even among seasoned businessmen). Many individuals in business thenly keep a close watch over day-by-day changes in market shares, so much so that market-share movement to them is almost synonymous to market information (Cooper, 2010).By comparing the profit obtained from various market share the organization may identify which market share gives more profit and should be focus on those customer desire and wich customer gives less profit and the organization may choose either to improve their product/ service or lowering te product/ service on that market share. Characteristics of new, loyal and woolly customers are particularly important for companies to understand. market analysts group customers into segments of recent new purchasers, high-volume purchasers and non-purchasers using customer transaction data, and analyze the resulting segments to identify their common characteristics.Attri butes of new customers provide a good air of a companys likely acquisition target market. Similarly, characteristics of lost customers may define less desirable market segments, or may reveal problems in customer service or product satisfaction. Improvements in retention programs are saving companies significant time and money property existing customers buying is much less expensive than acquiring new customers (Customer Acquisition, Retention and Attrition Analysis, 2014) Measurement that will show the situation of business are The number of new customers per quarter of yearTotal sales to new customers per quarter of yearSales to new customer as a proportion of total salesWhen business is good marketers can move over to take an evolutionary approach to customer acquisition and retention by continually optimizing branding, creative, advertising mix, and offer strategy. But during challenging business situations, an evolutionary approach is bound to yield underwhelming resul ts (Customer Acquisition & Retention, 2014). The diversity in sales in a market share from year to year, will act as indicator to the organization regarding percentage of new customers obtained or lost customers. Customer retention is the ongoing customer relationship that yields revenues from the sale of additional products or services. The revenues become more profitable as the customer becomes easier to serve. Since the customer is buying again it is assumed that less sales motion is required, customer service costs decrease, and the costs of acquiring customers decline. Customer loyalty encompass customer retention but also includes the customers testimony of the product or service to other potential customer. As for example, backchat of mouth recommendation is important to Southwest Airlines, whose reservation system has neer been accessible to travel agents.It has relied on advertising and customer loyalty to afford its message to potential customers. The airlines whi ch began flying in 1971, has consistently been profitable. Convinced that customer loyalty is a important factor in increasing profitability than is market share, Southwest Airlines strives to build customer loyalty by providing at low fares dependable, frequent service over relatively short routes, delivered by friendly employees (Epstein, 2000). Measures of customer loyalty were selected because they reflected both length (retention) and depth (cross sell) of the bank-customer relationship. length of relationship is reported by both category-reported customer retention rates (percentage of customers who remained customers during 1993) and mean customer-reported relationship tenure. Relationship depth is measured by division cross-sell rates, which record the percentage of customer households with six-fold accounts (account cross sell) or multiple services (service cross sell) (Hallowell, 1996). Companies are very aware that acquiring a new customer is more expensive than re taining an existing one, so companies cannot afford to lose customers receivable to poor service at the contact substance level.The contact center must be viewed as an essential reference work of the company, and an important part of the brand experience. Therefore, ensuring that the experience is pleasant, efficient, and satisfies the customers need is crucial to success. The most common method for measuring customer satisfaction is through surveys, either during or after the call. While this method provides some intelligence around the customer experience, it doesnt offer the most accurate view of customer satisfaction. This is due to the small sample size and the fact that the only questions asked are those deemed important by the enterprise. Surveys also lack detail, such as which of a customers experience with your company caused the review, which agent handled the interaction and what was the root cause of a dissatisfied call. Lacking this critical information, enacting mea ningful change is extremely challenging. Without the use of speech analytics, contact center operators are left with an incomplete view of customer satisfaction and a disconnect between the scores they receive and the actions that caused the scores.Speech analytics uncovers the reality of what happened during a call, enabling companies to improve the business processes and agent behaviors most affecting the customers experience. Nexidias Managed Analytic Services aggroup uses speech analytics applied science to locate the agent behaviors and business process that have the greatest impact on the customer. As example, the team first begins by identifying the calls which contain sentiments of dissatisfaction. By building searches that contain words such as unhappy, speak to a manager or frustrating, the team creates a category of calls in which the customer seemed upset, or the call escalated. More refined searches such as this is the xth time Ive called, or my hold time was excessiv e will yield further insight. The team drills into this category of calls to create sub-categories. These sub-categories show which types of calls most often contain frustration, such as billing calls or calls for technical assistance.The team also identifies which agents have the most dissatisfied calls and compares the percentage of these calls to total volume. The foster step in evaluating customer satisfaction begins by identifying behaviors and processes that typically cause customers to become upset. These include excessive transfers, requests for call backs, and long non-talk times. The team creates call categories which contain these issues, providing a foundation for performing root cause analysis. analyze the root cause arms companies with the information needed to understand why these trigger events occur, and what steps can be taken to prevent them. As behaviors and processes are modified, monitoring customer satisfaction becomes a continuous cycle, thus ensuring m aximum return on investment. (Nexidia Managed Analytic Services, 2010)The relationship of customer loyalty and customer satisfaction can be seen in the following miscellany of customers it is important to understand fully the environment which the customer is working, as extrinsic factors may drive them from one category to another Apostles. Customer who are loyal and satisfied and recommend the service to others. Mercenaries. Customers who may switch service suppliers to obtain lower price, but are highly satisfied. Hostages. Customer who are highly dissatisfied but have few or no alternative. Terrorists. Customers who have alternatives and use them, and also try to convert other customers by expressing their dissatisfaction (Epstein, 2000). Customer profitability of a various group of customer may be identify by measuring the profit gain by a group of customer from year to year. Profitability measures were determined based on their hypothesized relationship to customer satisfacti on and loyalty.Both of the measures used, ROA and NIE/Rev (non-interest expense as a percentage of total revenue), reflect profit at the individual division. See Roth (1993) for an analysis of similar performance measures in service firms. Given the intent of this study, NIE/Rev is preferred to ROA as a more appropriate measure of profitability. Retail bank profit can be separated into, first, the results of operations (revenue-enhancing as well as cost-incurring) which influence expenses and revenues that are not sensitive to interest rates, and second, treasury activities, which influence interest-sensitive costs and revenues. This piece addresses primarily non-interest-sensitive components of profitability, hypothesized to relate to customer loyalty. ROA contains both interest-sensitive and non-interest-sensitive components, while NIE/Rev is generated only from non-interest-sensitive costs (the revenue portion of NIE/Rev may be sensibly related to customer-relevant interest rates).Appendix 1 discusses ROA, NIE/Rev and the other measures used in more detail (Hallowell, 1996). By comparing the profit of different group of customer, the difference amount of profit will act as indicator which group of customer that gives high profit and low profit. other(a) than that, customer profitability may be determined by other tools of measuring customer performance such as market share, customer acquisition, retention,and customer satisfaction. Five reasons why customers can be unprofitable. They are (Six step to Customer Profitability Analysis, 2007) 1. The sales force is under continual pressure sensation to close deals and offers discounts to secure business within the sales period. 2. Pricing errors due to incorrect estimates of time.3. A one-size-fits-all approach to serving customers leading to over servicing where the business levels does not justify it. 4. Loss leaders are offered to customers who forever and a day shop around for a deal, in the expecta tion that profit will be recovered over the lifetime of the customer. 5. The connection between customers and costs is not made and over time some become a greater drain on resources.ConclusionCustomer profitability analysis provides a method to help firms see and understand the profitability of their customers. It takes effort and management sponsorship to make it feasible and worthwhile. It is a method and not an end in itself, but without it that investment in slick technology might not be such a good idea, if it only speeds up your ability to attract the wrong customers. Your allocation of resources to customers may also be based on erroneous information. If you have this understanding it uncovers new options for profitable growth and can help you work out which customers to attract, which to really hang on to at maybe greater cost. To help decide which to grow, CPA must be augmented with an understanding of potential lifetime value.It is recommended that Customer Profitability Analysis (CPA) be measured through Activity Based Costing. There are various group of customer, therefore it would be violate to differentiate them through segmenting b demographic or goegraphic or so on, to make it easier to recognised which group of customer that gives high/low profit, and which of the customers should be focus on, eliminate or re-engineering. Other than that, CPA may be measured by analyzing the customer performance measure of market share, Customer acquisition, retention, and customer satisfaction. Increase in Customer Profitability might be caused by increase in market share, customer retention which wil lead to increase in customer acquisition and probably increase in customer satisfaction.REFERENCESCooper, L. G. (2010). Market Share Analysis , 1.Customer Acquisition & Retention. (2014). Retrieved October 23, 2014, from Lenati http//www.lenati.com/our-expertise/customer-acquisition-retention Customer Acquisition, Retention and Attrition Analysis. (2014 ). Retrieved October 23, 2104, from Microstrategy Best in Business acquaintance http//www2.microstrategy.com/download/files/Solutions/byDepartment/CRM/Customer_Acquisition.pdf Dikoli, M. S. (1995). Customer Profitabilit Analysis An ABC Approach. 5. Epstein, M. J. (2000). Management Accounting Guideline. Customer profitability analysis , 8. Faculty of Finance and Management. (2002). Customer Profitability Analysis , 36. Nexidia Managed Analytic Services. (2010). Customer Satisfaction Analysis , 2. Six step to Customer Profitability Analysis. (2007, May 7). Retrieved October 23, 2014, from Accounting Web http//www.accountingweb.com/topic/six-steps-customer-profitability-analysis