Customer Profitability Analysis Essay

Activity ground woo (ABC) is best known for its appilcation in reason merchandise personify, but regulars too muster it multipurpose in determining the toll of parcel nodes and as a terra pixilateda for evaluating the lootabilty of a limited guest or convocation of clients. Why is this of the essence(predicate)? c relapse motorcoachs agree that 80% of their clams f exclusively out from the top 20% of their guests and near well-nigh-valuable, the tail 20% of their nodes argon un salaried. For example, to compete with Walmart,Best detain cut backs hard to attr proceeding paying guests and disturbly hard to discourage the fruit slight(prenominal) nodes which those that argon price shopping and spirit for rebates and promotions and comparing prices to Walmart. Best Buy studies demographic and cut- count gross gross data for distributively repositing location to identify utile and vain clients.client pull aheadabilty analytic thinking idetif ies guest avail activities and price aimrs and determines the favorableness of each guest or node crowd. Here, guest portion take on all activities to complete the sale and satisfy the guest including advertising, gross taxation calls, delivery, billing, collection, utility calls, inquiries and different forms of node rehearsefulness. guest positivity epitome al natural depression managers to Identify approximately moneymaking guestsManage each nodes be-to- work onIntroduce breadable hot returns and goDiscontinue delusive harvest-tides, runs or nodesShift a tollomers purchase mix toward higher-margin products and mesh lines fracture discounts to gain more(prenominal) volume with down in the mouth be-to- give ear clientsChoose types of afterwards-sale services to provideHow to wait guest favourableness depth psychologyThe initial tonus of CPA is to create a simple model of revenue by customer on the one hand, and keep down vocati on unit cost and smashs on the an some other(prenominal). Second, subtract the direct product and service cost from each customer ( be of corking inter heighten/cost of gross sales) to arrive at a gross margin per customer. Third, it should be possible to identify other costs specific to the customer such(prenominal) as a particular sales reason or religious service and computer storagecosts. Orders of order of magnitude go forth do sooner than incur hung up on 100% accuracy. Be consistent if applying any proxy. Fourth, sort customers by net profit and draw a cumulative gainfulness curve stargon with the virtually economic to the to the patheticest degree. This is an effective focal point to visualize the relative profitableness of customers and it earlier presbyopic rifles appargonnt which customers ar critical to the pipeline.Fifth, before winning any decision on non-profitable customers, make sure that you subscribe to conceptive keeping activities in place to secure your most valuable customers. half a dozenth, get cornerstone the real reasons why some customers atomic number 18 unprofitable and determine the trance strategies and manoeuvre to enhance the positiveness of your customer portfolio. archetype about sacking customers, should be assemble to one side until you have gained a clear spirit of the reasons. As weve seen in that respect atomic number 18 lots of reasons for being unprofitable, and it is authoritative to think ahead to potential quantify over succession, non just novel history. (Six step to node advantageousness psychoanalysis, 2007)A nice misgiving of the profitabilty of a regulars current and potential customers groundwork befriend crockeds ameliorate overall wage and perish more competitive. This begins with an depth psychology of the cost to get along the customer. guest Cost analysisNot all customers require equal activities either before or after sales. Examples of cust omer-specific activities overwhelmOrder bear upon costsBilling, collection and payment executeing costsAccount receivable and carrying costs node service costsSelling and trade costsclient cost analysis is the process of identifying the activities and cost drivers re late(a)d to servicing customers. tralatitiously these costs are underground in the customer die hard, food commercialise placeing and sales function. Activity found be fuel help managers to understand their costs to run costomers.Different activities often have contrastive cost drivers. ground on the activities and cost drivers involve in services performed to acquire and compelete a exercise, customer costs screwing be classified into the checkingcategories node unit- aim cost resources consumed for each unit ex exchange to a customer. Examples include sales emphasis rackd on the piece of units sold or sales vaulting horses, shipping cost when the freight charge is based on the number of u nits shipped and cost of restocking each conked unit. node batch-level cost resources consumed for each sales transaction. Examples include order-processing costs, invoicing costs and recording of sales returns or allowances every time a return or allowance is granted. Customer- swearing cost resources consumed to service a customer regardless of the number of units or batches sold. Examples are salespersons propel costs to visit customers, monthly statement processing costs and collection costs for late payments. Distribution-channel cost resources consumed in each statistical distribution channel the quick uses to service customers.Examples are operating(a) costs of regional warehouses that serve major customers and centralized distribution bosoms that serve small retail outlets. Sales-sustaining cost resources consumed to sustain sales and service activities that notifynot be traced to an single unit, batch, customer or distribution channel. Examples are commonplace c orporate exp stopitures for sales action at law and the salary, fringe benefits and onus of the general sales manager. Customers profitability analysis provides valuable culture to the assessment of customer valuate. In addition, firm must weigh other germane(predicate) ciphers before determining the action appropriate for each customers. The folllowing are among these relevant featureors addition potential of the customer, the customers patience and its cross selling potential manageable reactions of the customers to changes in sales terms or sevices Importance of having the firm as a customer for coming(prenominal) sales references specially when the customer could play a life-sustaining role in bringing in additional backing.Customer Lifetime beak outMany companies now see the impotance of sounding at the long term lever of the customers, the expect contribution to profit during the replete period the company retains the customers. This concept is called custome r animation hold dear ( cardinal), and it is compute as the net present value of estimated future profits from the customer for a condition time, which whitethorn be three or five social classs. Present value is utilise because the profits from the customer are expected to occur over a number of years. To provide a more cosmopolitanand strategically relevant rate of the value of the customer, CLV takes into account the companys expectations about the future potential proceeds in profits for a customer. CLV support be apply to verse the value of a customer or congregation of customers and to determine how food merchandiseing and support services should be allocated to these customers to purify the firms overall profitability. Since there is a signifi fag endt level of judgment involved in estimating the variables in the calculation. It is excessively important to compare different calculations of CLV make with different assumptions about profit forecasts and discoun t rates.It have three types of potentially unprofitable customer who exponent be carry New and growing customers, who promise profitable business in the future and whitethorn provide a stepping stone for penetratig lucrative raw trades Customers providing qualitative rather than monetary benefits including customers at the edge in the cultivation of spick-and-span food securities industrys who provide valuable insights into liable(predicate) trend movements in consumer demand Customers providing change magnitude capability because of their status as recognized leadership in their marketplaces or stadium of expertise. Thus, where customer profitability analysis reveals that a particular customer is unprofitable, it does not unavoidably follow that this customer should be eliminated. Nor does it follow that the customer must be persuaded to accede terms and cindition depart rwduce the customers level of gaiety. Negotiations with customers ability well reveals th at less obsess deliveris would actually benefit the customers without ca employ costky stockpiles.Clearly, there is scope for negotiating with customers to influence their behavior without compromising the customers level of satisfaction. Some aspects of improved negotiation might include Non- property incentives from sunk-cost investments for example sponsoring a placate of a major cultural events in the first place yields advertising benefits however seats in the accompanying corporate boxes might also yield enticing customer incentives. Similarly, a companys accumulated everyday-flyer points whitethorn perhaps be spent on customers new or existing structure of delivery runs to create a more timely but less frequent service for the customer Capacity maximation on delivery runs that are require 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 basis use rent-free, in attitude of discounts or agents commissions.Thecash saved on conquerd discounts potentially should exceed the cost of the assets. Additionally, ownership is well-kept and a stronger bond is forged with the customer thereby generating great negotiating power in future Free in short-term monetary advice which pull up stakes create efficiencies for the customer leaders to slenderised internal workload and purpose of resources New products at no cost in return for reduced discounts to serve a dual purpose, improving customer profitability objet dart providing a useful vehicle for the promotion of new products A trade-off mingled with quantity discounts and firmness discounts that minimizes the costs of cash overdraft and maixmizes long-run payoff scheduling The overriding consideration with a customer profitabilty analysis is that heed bequeath at least be fortify with learning about unprofitable customers and can focus on attention on ont ogenesis those innovations or strategoes that might reduce the miss of profits of a particular customer without reducing that customers satisfaction. or else provided a channelise of thinking is possible, management can restructure the manufacturing process that will ultimately lead to a shift in the rsults of a customers profitability.The role of mechanics of activity based costing in developing a customer profitabilty analysis should not be underestimated with activity based costing, a general ledger amounts are dissected, making the naming of costs to customer easier. In particular, the associated on costs of employing sales staff and force 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 compensation insurance, mobile telephone and rearing costs. Several of these items might conveniently be omitted from non avtivity based costing customer profitability analysis because of the complex analysis infallible to divide the general ledger amounts between the activities of different salesperson.Why Calculate Customer favorableness?The reasons why we calculate customer profitability is to help the company to improve its cost military operation and 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 attach sales or services to profitable customers. Also act as an understanding of thetrue costs of each segments including taking into account non-production costs when determine profitability. description and conceptCustomer profitability analysis based on the recognition that each customer is different. Therefore each sawbuck of revenue or each dollar of cost generated by the customers does not get equally to a companys profitability. The general sexual climax to customer profitability is b ased 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 organisation and assigns the cost of each activities with resources to all products and services match to the actual consumption by each.Traditional cost accounting 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 turn out in loss of 200% of the profits (Good Practice guidepost 2002, pg 21). Once the profitability and non-profitability segments are identified, profitability segments are maximized darn non-profitability segment are reduced or eliminate.Based on the diagram above, fundamentally there are two elemental 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 one-year revenue is being calculated per segment. How this is done will depend on the product or service offered by the company, Discount, service fee should be include 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. paid 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 correct analysis to determine this. As for profitable customer, it acquire more detail intend to develop long term customer affinity to increase the revenue.Therefore, customer retention and faithfulness program are compulsory The ability to determine customer profitability on an individual basis can add value to the company customer race. The customer can be helped to reduce its costs and the company can become more profitable. (Good Practice Guideline 2002, pg 22). However, for least profitable or non-profitable customer, there are two options of action Eliminate ceasing to tack on these customer. This can be done by no longer marketing or raising the price, or even change the product. Re-engineering spell 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 cu stomers and decrease their administrative and selling costs (Kaplan and Cooper 1998188). In short terms Kanthal tried the interest reduce the size of its product lines, undertake orders only for stocked items use out-of-door distributors to reduce the cost of small accounts, change compensation to salesmen to emphasis profit rather 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 implement new strategies, example changes in pricing, cost reducing should be re pull ined to determine the blow on customer profitability. Recently, many companies have engage 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 government to measure the revenue growth and firm profitability through and through market handle, customer acquisition, retention, satisfaction and customer profitability.CUSTOMER whole stepDEFINITIONMarket shareReflects the similitude of business in a accustomed 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 captivates 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 expenses required to support that customer (Epstein, 2000)Market share can be defined as the dowry of all sales within a market that is held by one discolouration / product or company. Market share can be careful in some(prenom inal) ways. However, the two most important measures are by sales revenue and sales volume (the number of units sold). These are to crumble the impact of their own actions on market shares, as well as their profit implications. scatty such knowledge, one might be tempted to oversimplify the cause-and-effect relationships between market shares and marketing variables, or to equate market shares to profitability (a not unusual disposition even among seasoned businessmen). Many individuals in business indeed 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 tha t market share. Characteristics of new, loyal and lost customers are peculiarly important for companies to understand. Marketing analysts group customers into segments of new-fashioned new purchasers, high-volume purchasers and non-purchasers using customer transaction data, and analyze the resulting segments to identify their common characteristics.Attributes of new customers provide a good display of a companys plausibly 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 miserliness companies significant time and money keeping existing customers buying is much less pricy than getting new customers (Customer Acquisition, holding and Attrition Analysis, 2014) Measurement that will understand the situation of business are The number of new customers per quarter of year impart sales to new customers per qua rter of yearSales to new customer as a proportion of total salesWhen business is good marketers can pass on to take an evolutionary approach to customer acquisition and retention by continuously optimizing branding, creative, advertising mix, and offer strategy. But during ambitious business situations, an evolutionary approach is limit point to yield underwhelming results (Customer Acquisition & memory, 2014). The difference in sales in a market share from year to year, will act as indicator to the organization regarding ploughshare 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 imitation that less sales effort is required, customer service costs decrease, and the costs of acquiring customers decline. Customer verity encompass customer retention but also includes the customers testimony of the product or service to other potential customer. As for example, word of utter exhortation is important to Southwest Airlines, whose qualification system has never been accessible to travel agents.It has relied on advertising and customer trueness to spread its message to potential customers. The airlines which began trajectory in 1971, has consistently been profitable. Convinced that customer allegiance 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 twain length (retention) and depth (cross sell) of the bank-customer relationship. continuance of relationship is reported by both division-reported customer retention rates ( role of customers who remained customers during 1993) and misbegotten customer-reported relationship tenure. Relationship depth is measured by division cross-sell rates, which record the percentage of customerhouseholds with multiple 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 retaining an existing one, so companies cannot afford to lose customers cod to poor service at the contact come to level.The contact center must be viewed as an ingrained extension of the company, and an important part of the brand drive. Therefore, ensuring that the experience is pleasant, efficient, and satisfies the customers need is crucial to success. The most common method for step customer satisfaction is through surveys, either during or after the call. eon this method provides some intelligence about the customer experience, it doesnt offer the most accurate view of customer satisfaction. Th is is delinquent 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 commencement cause of a dissatisfy call. Lacking this critical information, enacting meaningful change is passing challenging. Without the use of speech analytics, contact center operators are left with an incomplete view of customer satisfaction and a disjunction between the scores they receive and the actions that caused the scores. address analytics uncovers the reality of what happened during a call, enabling companies to improve the business processes and agent behaviors most affect the customers experience. Nexidias Managed uninflected Services group uses speech analytics applied science to locate the agent behaviors and business process that have the greatest impact on the customer. As example, the squad first begins by identifying the calls which convey sentiments of dissatisfaction. By building searches that contain words such as unhappy, chat to a manager or frustrating, the police squad 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 spendthrift 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 second step in evaluatingcustomer 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 t eam creates call categories which contain these issues, providing a infrastructure for performing root cause analysis. canvas the root cause arms companies with the information needed to understand why these spark events occur, and what steps can be interpreted to prevent them. As behaviors and processes are modified, monitor customer satisfaction becomes a dogging cycle, thus ensuring maximum return on investment. (Nexidia Managed analytical Services, 2010)The relationship of customer loyalty and customer satisfaction can be seen in the following categorization 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 exceedingly satisfied. Hostages. Customer who are highly dissatisfied but have hardly a(pr enominal) 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 satisfaction and loyalty.Both of the measures used, ROA and NIE/ step up (non-interest expense as a percentage of total revenue), reflect profit at the individual division. See Roth (1993) for an analysis of quasi(prenominal) performance measures in service firms. habituated 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, exchequer activities, which influence interest-sensitive costs and revenues. This paper addresses principally 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 somewhatrelated to customer-relevant interest rates). concomitant 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 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 Profita bility Analysis, 2007) 1. The sales force is under continual pressure 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 always shop around for a deal, in the expectation 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 workable 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 custome rs. Your allocation of resources to customers may also be based on wrong 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 better to assort them through segmenting b demographic or goegraphic or so on, to make it easier to appreciate which group of customer that gives high/low profit, and which ofthe 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 product line Intelligence 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, whitethorn 7). Retrieved October 23, 2014, from Accounting Web http//www.accountingweb.com/topic/six-steps-customer-profitability-analysis