WHY MEASURE CUSTOMER PROFITABILITY?
Running a business is rarely straight forward. There are many moving parts to consider before you measure customer profitability:
According to Wikipedia, Customer Profitability Analysis (CPA) is a management accounting and a credit underwriting method, allowing businesses and lenders to determine the profitability of each customer or segment of customers, by attributing profits and costs to each customer separately.
When you measure customer profitability, you improve customer profitability
Markets change on a routine basis
Customers’ behaviour changes due to a variety of reasons
New/competing products are introduced on a routine basis
Competitors can alter their strategy
Raw material costs are constantly changing
Manufacturing productivity can be lost or gained
Many of these changes are beyond your control but must be managed on a proactive basis. All of these factors can impact your customer profitability,making it one of the biggest challenges management faces.
The Importance of Customer Profitability:
The ability to measure customer profitability is rarely a simple task. In some areas, your customers might all pay similar prices for the product or service you provide. However, in many cases, there will be additional segments of your business where it’s more complicated than that. The prices you charge are subject to discounts, long-standing relationships and competitive pressures.
Larger customers may have been given concessions over time that actually makes their business unprofitable to service.In other cases, smaller businesses might really need you, but are in a position where they can’t pay higher prices. And then, there are those unicorns who will pay the prices you set and agree to increases when you announce them.
With that mixture – and more – of different customer situations and needs, it can be difficult to accurately measure customer profitability. It is even more difficult is to identify the reasons for a gain or fall in profitability over time.
Uncover the Key Reasons for You Customer Profitability Problems
When it comes to analyzing customer profitability, many businesses face a myriad of issues. Due to the dizzying number of variables that affect customer profitability, it’s increasingly more difficult to identify a problem or problems.
It’s time consuming
Collecting data from multiple systems and spreadsheets is time intensive and that’s before you’ve tried to decipher the often confusing, but not always relevant results they provide.
It Can Be an Error Prone Process
When people are responsible for selecting, consolidating, inputting and uploading data into a spreadsheet, mistakes are often made. That effects the analysis, in some cases making it completely incorrect. When these mistakes occur, the resulting analytics cannot be trusted. Many organizations produce conflicting reports or produce results that the business doesn’t believe.
- The Granularity of the Data
It can also be difficult to get the level of detail required to make the resulting data actionable. If all goes well and the analysis shows you the sector, region or customers that are responsible for the unexpected fall in customer profitability, that’s helpful. More detailed information is required, however, to understand how profitability is being impacted AND to how act on it. Without this level of detail, you’re still in the dark about how to improve the situation.
With the right data analytics solution, it immediately becomes easier to analyze a variety of scenarios in a matter of minutes. No need to chase and consolidate data from multiple systems. The data has already been cleansed, so you know it’s right. Most importantly, the data can be viewed at any level of detail. Summary data can help you identify patterns. Detailed data can be used to assist in the decision-making process.
Product Mix
As you already know, your product mix has a big impact on customer profitability. Many businesses spend a lot of time developing the right product mix to maximize profitability. If you don’t take the time to get this right and don’t have a system in place to optimize your product mix, it can impact customer profitability and result in profit leakage.
To get this right, you need to understand:
Exact costs associated with producing and distributing each product, with the help of value-stream analysis.
Compare your total costs versus your pricing.
Determine exactly how much each customer is paying per unit.
Identify customers or customer types that are the most profitable – it’s not always your biggest.
Only when you have a handle on your product mix and how it affects your customer profitability, can you move forward and find ways to improve customer profitability.
Understanding Your Product Mix
Product mix can drive profitability. It’s important to understand product mix at all levels within the sales channel (This graph shows product mix for a particular customer who appears to buy more than his fair share of low margin goods.).
Pocket Profit
The pocket profit of your business’, products or services, is another key area to identify. Pocket profit refers to the final profit that the company makes, once all costs associated with the production, delivery and support of your products or services are fully calculated. This is a long way from looking at the base price of your product and the price at which you sell it to your customers. It includes everything from packaging and freight costs to customer discounts and other typically non-invoice cost details. Having pocket-profit information can allow a CFO to educate his or her peers, CEO and the board whether pricing policies are working. If, for example, the data shows that sales and marketing are pushing pricing strategies that sell products but don’t contribute to the overall value of the business, those policies can be adjusted.
Many Costs Affect the Final Pocket Price
A variant of pocket margin is pocket price. This graph shows non-invoice costs that are eating away at profitability from a pricing strategy. This information is vital when trying to determine true customer profitability.
Customer Profitability Problems require detailed analysis
There are a variety of factors that can impact customer profitability. Many finance organizations spend much of their time collecting data and manipulating it in spreadsheets in order to measure customer profitability. Besides being error prone, the amount of effort required to perform this analysis limits its effectiveness. This author suggests that it may be time to modernize your finance department by acquiring a margin analysis solution like EZlytix. If you want to find out more about how EZlytix can help unlock your company’s true potential, get in touch with us today.