Customer Profitability Analysis Flashcards
What is Customer Profitability Analysis?
Customer Profitability Analysis (CPA) is a tool used to determine the profitability of individual customers or customer segments by comparing the revenue they generate with the costs associated with serving them.
CPA helps organizations identify which customers contribute the most to their profits and which might be costing them money.
Why is Customer Profitability Analysis important?
CPA is critical because:
1. Not all customers contribute equally to profitability.
- It highlights the differences in revenue and costs for various customers.
- Managers can focus on retaining profitable customers and making strategic adjustments for less profitable ones.”
What are the 4 overall steps in Customer Profitability Analysis?
- Identify or Classify Customers
- Measure Revenue for Each Customer
- Measure the Full Service Cost for Each Customer
- Determine Customer Profitability
How is step 1 in CPA done?
We first group customers by relevant criteria, such as location, purchasing behavior, demographics, or revenue potential.
Example:
A distribution company might group customers into:
Large supermarkets
Hospitals
University canteens
Corner shops.
How is step 2 in CPA done?
In step 2 we meausre the revenue generated by each customer.
Revenue is the inflow of assets from customers in exchange for products or services. It can vary based on:
* Prices paid (e.g., discounts).
* Order frequency.
* Product mix.”
How is step 3 in CPA done?
We then calculate the total costs associated with serving each customer, which include:
Direct Costs: Easily attributable to a specific customer (e.g., cost of goods sold).
Indirect Costs: Overheads allocated to customers based on activity-based costing (ABC).”
Formula for Allocating Costs:
Cost Allocated = Cost per Activity ∙ Activity Meausure
How is step 4 in CPA done?
In step 4 we determine the customer profitability.
Customer profitability is the difference between revenue and the full cost to serve a customer.
Formula:
Customer Profitability =
Revenue from Customer - Total Cost to Serve Customer
How does the pareto principle work in Customer Profitability Analysis?
Based on the Pareto Principle (80/20 rule), 80% of profits often come from 20% of customers.
CPA helps identify these high-value customers so that resources can be focused on retaining them.
Why is it important that we understand the difference of contribution margin, product margin, and customer margin?
Understanding the differences between contribution margin, product margin, and customer margin is important because they provide distinct insights for decision-making:
What is the contribution margin?
Contribution Margin: Measures the portion of a customer’s revenue that remains after deducting variable costs. It shows how much the customer’s purchases contribute to covering fixed costs and profits.
Contribution Margin =
Revenue from Customer - Variable Costs for Serving Customer
What is the product margin?
Product Margin: Focuses on the profitability of specific products purchased by a customer, including direct production and selling costs.
Product Margin =
(Revenue - Cost of Goods Sold)/Revenue ∙ 100%
Use: Identifies which products a customer buys are most profitable.
What is the customer margin?
Customer Margin: Evaluates the overall profitability of a customer by subtracting all costs to serve them (e.g., logistics, service, marketing).
Customer Margin =
Revenue from Customer - Total Costs to Serve Customer
Use: Guides decisions on retaining, adjusting terms, or dropping customers.
What decisions do we make from the Customer Profitability Analysis?
After calculating customer profitability, you decide:
1. Which customers to focus on retaining.
2. Which customers might need adjusted pricing or service terms.
3. If any unprofitable customers should be dropped or handled differently.
What are the limitations of the Customer profitability Analysis?
- Data Intensity:
Requires detailed data on costs and revenues. - Customer Reactions:
Adjusting terms for less profitable customers may harm relationships.
