Hilton • Maher • Selto

6Managing Customer Profitability

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Using ABC to determine the activities, costs, and profit associated with serving specific

customers.

Using ABC to determine the activities, costs, and profit associated with serving specific

customers.

For various reasons, some customers are less profitable than others.

For various reasons, some customers are less profitable than others.

Customer makes frequent order changes.

Customer needs special parts.

Customer is difficult to please.

For

E

xam

ple

Customer Profitability Analysis

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Customer Profitability Analysis

Once we know which customers are the least profitable, we can modify our relationship to

improve profitability.

Once we know which customers are the least profitable, we can modify our relationship to

improve profitability.

I hate to do this, but

we just can’t continue

doing business with

you.I hate to do this, but

we just can’t continue

doing business with

you.

We’ll send a team to your plant next week and help you set up an ordering system that gives

us more lead time.

We’ll send a team to your plant next week and help you set up an ordering system that gives

us more lead time.

If you ask for fewer changes, we can charge you less!

If you ask for fewer changes, we can charge you less!

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There are two primary steps:There are two primary steps:

Customer Profitability Analysis

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Measuring Customer Profitability

Studies have shown that only 20% of a company’s customers contribute to profits.

The remaining 80% generate losses.

Studies have shown that only 20% of a company’s customers contribute to profits.

The remaining 80% generate losses.

Profit can be measured by:Profit can be measured by:

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Measuring Customer Profitability - Example

Cus

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er P

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Customer #

Assume Koala Camp Gear looks at 5 of its customers.

Assume Koala Camp Gear looks at 5 of its customers.

Bar graphs are common

analytical tools.

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Measuring Customer Profitability - Example

Cus

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Question:

Why are these two customers

not profitable?

Customer #

Note that attention should be focused on customers #102 and #114.

Note that attention should be focused on customers #102 and #114.

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Measuring Customer Profitability - Example

Comparing the customer-related costs for each customer can reveal helpful insights.

Comparing the customer-related costs for each customer can reveal helpful insights.

For Customer #102, costs of order processing,

engineering/design changes, and special

handling are above normal.

For Customer #102, costs of order processing,

engineering/design changes, and special

handling are above normal.

For Customer #114, the cost of special packaging is 4× the norm. The cost or special handling is 6×

the norm.

For Customer #114, the cost of special packaging is 4× the norm. The cost or special handling is 6×

the norm.

We Investigate and find. . .We Investigate and find. . .

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Processing Orders Sales Contacts Sales Visits Processing

Shipments

Processing Orders Sales Contacts Sales Visits Processing

Shipments

Typical Customer-Related Activities Include:Typical Customer-Related Activities Include:Typical Customer-Related Activities Include:Typical Customer-Related Activities Include:

Billing Engineering/Design

Changes Special Packaging Special Handling

Billing Engineering/Design

Changes Special Packaging Special Handling

Identify Effective & Ineffective Customer-Related Activities

Study closely all the customer-related activities that drive cost.

Study closely all the customer-related activities that drive cost.

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Customer Profitability Analysis

HealthWave, Inc. sells non-prescription pharmaceuticals to

three major customer types:

•Pharmacies

•Groceries

•Herbal Therapists

HealthWave, Inc. sells non-prescription pharmaceuticals to

three major customer types:

•Pharmacies

•Groceries

•Herbal Therapists

Which of these Which of these customer customer

groups is the groups is the most most

profitable for profitable for HealthWave?HealthWave?

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Sales Pattern AnalysisExh.6.5

At this point, it would appear that Pharmacies

provide the highest contribution margin

ratio.

Let’s examine further.

At this point, it would appear that Pharmacies

provide the highest contribution margin

ratio.

Let’s examine further.

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Sales & Admin Cost Analysis

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Selling Cost Analysis

HealthWave sells its products using sales personnel in the field and telephone ordering. A summary of those cost appear below. Note that Herbal Therapists appear

to have the lowest selling costs.

HealthWave sells its products using sales personnel in the field and telephone ordering. A summary of those cost appear below. Note that Herbal Therapists appear

to have the lowest selling costs.

Exh.6.6

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Marketing Cost Analysis

Marketing costs include personnel, databases, equipment, and facilities. HealthWave’s costs can be broken down into Marketing Management Costs, Promotion and Incentive Costs, Advertising

Costs, and Catalogue Development Costs.

Again, Herbal Therapists have the lowest marketing cost.

Marketing costs include personnel, databases, equipment, and facilities. HealthWave’s costs can be broken down into Marketing Management Costs, Promotion and Incentive Costs, Advertising

Costs, and Catalogue Development Costs.

Again, Herbal Therapists have the lowest marketing cost.

Exh.6.7

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Distribution Costs Analysis

Distribution costs include packing, shipping and delivering products or services to customers. HealthWave delivers goods

using its own trucks and a private delivery service, PackageXpress.

This time, Grocery customers have the lowest distribution cost.

Distribution costs include packing, shipping and delivering products or services to customers. HealthWave delivers goods

using its own trucks and a private delivery service, PackageXpress.

This time, Grocery customers have the lowest distribution cost.

Exh.6.8

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G & A Costs Analysis

Typically, general and administrative costs are not directly customer-related. These costs can often be difficult to trace to specific customers. HealthWave breaks them into two broad

categories; Customer Service and Manufacturing Support

Again, Herbal Therapists have the lowest marketing cost.

Typically, general and administrative costs are not directly customer-related. These costs can often be difficult to trace to specific customers. HealthWave breaks them into two broad

categories; Customer Service and Manufacturing Support

Again, Herbal Therapists have the lowest marketing cost.

Exh.6.10

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Customer Profitability Analysis

Finally, we put all the information together to determine which customer-type is the most profitable. The Groceries appear to be

the most profitable customer.

Finally, we put all the information together to determine which customer-type is the most profitable. The Groceries appear to be

the most profitable customer.

Exh.6.11

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Common-Sized Profit Statements

To better compare different sets of data, the dollar amounts can be recast as a percentage of revenues.

To better compare different sets of data, the dollar amounts can be recast as a percentage of revenues.

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What To Do?

The Pharmacy customers are not contributing to HealthWave’s profitability. What are the options?

The Pharmacy customers are not contributing to HealthWave’s profitability. What are the options?

Do NothingDo Nothing

Drop pharmacy customers

Drop pharmacy customers

Decrease operating

costs

Decrease operating

costs

Increase efficiency of

serving pharmacy customers

Increase efficiency of

serving pharmacy customers

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End of Chapter 6

Common-Common-size size

THIS!THIS!