Customer Profitability Requirements
In today’s economy, it is important to understand which customer relationships are profitable and which are not. A closer look at individual customers can help transform your company’s bottom line. Understanding individual customer profitability can help you target high-value customers and tailor products and service offerings to their specific needs. That can lead to valuable long-term relationships – which can create a significant competitive advantage.
Most organizations today assess performance using only sales revenue or profitability metrics. This approach may be causing you to miss valuable opportunities to make your business more profitable. Customer profitability is the process of applying the accounting concept of profit and loss to a customer relationship. Measuring the profitability of a firm’s customers or customer groups can often deliver useful business insights. In most cases, a very small percentage of customers account for a large portion of the business profit. Often organizations find that their worst customers actually cost more to serve than the revenue they deliver. These unprofitable customers can actually detract from company profitability.
In the coming years, many companies will implement customer profitability analysis as a method to enhance profits. Organizations that have already implemented customer profitability analysis may need to make some revisions to their processes to accommodate new service delivery mechanisms such as social media, e-procurement, supply chain improvements, and the like.
Before moving forward with a customer profitability analysis, it is important to understand industry best practices and potential cultural changes that may result from using a customer profitability approach. The Enfocus Solutions Requirement Coach™ includes industry best practice summaries for se by subscribers. We have found these tools to be very helpful for business analysts to use as a practice aid for conducting business process analysis. Below, we will examine how customer profitability analysis can change the corporate mindset of an organization based on information provided by PriceWaterhouseCoopers and best practice recommendations from an APQC report.
According to PriceWaterhouseCoopers, customer profitability analysis lays the foundation for a new corporate mindset where the bottom line is considered in every customer interaction. This difference in mindset is contrasted in the table below.
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Traditional Approach
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Customer Profitability Approach
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All customers are treated equally, or worse, prioritized by revenue alone.
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Customer service is driven by a bottom- line customer contribution to help maximize value and make sure each customer relationship is profitable.
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Sales team is motivated to sell higher revenue or margin products.
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Sales team is motivated to ensure that only profitable deals are priced and sold.
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Little/no awareness of how individual customers impact the bottom line.
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A clear course of action is designated for each category of customer; i.e., targeting high-performing customers or dedicating teams to mediate unprofitable customers.
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Company operates with minimal understanding of how to increase customer profitability.
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Company has a deeper understanding of customer profitability and how it can benefit the entire organization.
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Internal product groups work in separate silos, often with competing objectives.
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Internal product groups operate holistically, with the same objective: to achieve a profitable relationship with each customer.
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Customer profitability is dictated by the customer’s mix of products.
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Customer profitability is dictated by the customer’s mix of products and interactions with the business.
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The American Productivity and Quality Center (APQC) conducted a best practice research study for calculating and reporting customer profitability. Key findings from this study are presented below.
Governance of customer profitability initiatives
- Key finding 1: At best-practice organizations, customer profitability is owned by marketing, with finance as a key stakeholder.
- Key finding 2: Study participants have defined a small, dedicated group of two to five individuals who are involved in calculating and reporting customer profitability.
Calculating and Reporting Customer Profitability
- Key finding 3: Best-practice partners have developed an enterprise-wide view of the customer.
- Key finding 4: Best-practice partners have clearly defined customer segments and sub-segments. Most have developed five to nine macro customer segments.
- Key finding 5: Best-practice partners use multiple bases for customer segmentation such as needs, geography, and customer profitability.
Calculating customer profitability
- Key finding 6: Best-practice organizations capture revenues and costs at the transaction level for each specific customer account.
- Key finding 7: Best-practice organizations take a holistic view of customer profitability and include lifetime value and customer valuation metrics in the calculation.
- Key finding 8: Best-practice organizations include the majority, but not all, of their costs in the customer profitability calculation. Best-practice organizations use appropriate methods for cost assignment.
- Key finding 9: Best-practice organizations all work closely with IT. Enabling technologies for calculating customer profitability include data warehousing, CRM systems, data mining, external databases, and predictive analytics.
Reporting customer profitability
- Key finding 10: At best-practice organizations, customer profitability information is used as an input in many areas.
- Key finding 11: Best-practice organizations emphasize intelligence (e.g., decision support), not routine reporting, in customer profitability information dissemination.
Putting customer profitability into Action
- Key finding 12: Best-practice organizations secure buy-in from the users and upper-level support for customer profitability initiatives.
- Key finding 13: Best-practice organizations hold employees accountable for customer profitability.
- Key finding 14: Best-practice organizations use customer profitability and segmentation to appropriately align sales and marketing resources.
- Key finding 15: Best-practice organizations have specific programs/sales efforts geared to their most valuable customers.
- Key finding 16: Best-practice organizations successfully convert unprofitable customers to profitable customers.
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