Using customer profitability to become customer-centric

[Editor’s Note: We initially published this eLetter in 2002. Since that time, we have assisted many clients in gaining a better understanding of their customers and profitability. I hope you find it useful.     – dpm]

Some companies calculate the net profitability of every one of their customers every month!  Why? Because they have discovered that the company profitability is built “one customer at a time” and that all customers are not the same.

What should be included in your calculation?
Every cost in a company should be allocated to a customer. In a manufacturing company, for example, costs should include the product cost, freight and delivery, cost of generating and processing an order and collecting from the customer (from sales, sales support, customer service, technical service, order entry, scheduling, rent, warehousing, picking, staging and loading, insurance, accounting, credit and collections, terms, warranty costs, cost of capital for plant, equipment, information technology), R&D, and corporate overhead.

Why spend so much effort at this micro level?…Because companies have discovered that examining profitability at the customer level provides not only amazing data about the cost of acquiring, servicing, and maintaining customers, but perhaps most importantly can provide insight into new product and service opportunities to gain a better share of their best, most profitable customers.

Cost of serving customers. One of our distribution clients found that, due to the cost of processing and special packaging an order, order size was a far greater determinant of profitability than gross margin. Product and pricing was adjusted to reflect the value of special packaging, while introducing new standard packaging that covered a broader number of customer needs.

Cost of acquiring new customers. Another client discovered that marketing programs that were designed to grow revenue were inherently flawed. One program, (judged a great success since it added $7 million in revenue by the second year) added customers that cost $2,000 to acquire, but who only generated $1,350 of profit during their tenure as a customer. In truth the company lost $650 on each new customer acquired under this program.
                                                           
Insights into best customers.  Opportunities to cross-sell additional services and products. One client found that its best customers in the construction trade were notoriously poor planners and had difficulties forecasting demand. By providing a rather basic scheduling service for these clients, it now provides better service at lower costs and charges a premium price. It has solved a real issue of pain for both customer and supplier …AND…with the increased knowledge about the customer’s needs, it has begun to develop and sell additional products to their best customers.

Calculating Profitability per customer does not require a significant new investment in Information Technology or Accounting Systems? Most of the small and middle market businesses we work with have implemented some form of customer tracking software and cost tracking software(CRM, Manufacturing, Order Processing, etc….some may have Activity Based Costing) which is sufficient to get started. Following the customer interaction through the company’s business processes and establishing some cost allocations is the next step. This is an iterative process with calculations and allocations improving over time. Typically, the segmenting of customers by profitability is easy to discern and companies find that they can begin to implement measures quickly.

Focusing on customer profitability is key to becoming a truly customer-centric organization. Calculating net profitability by customer is the start – sustainable improvement to company performance requires changes to strategy, structure, organization, culture, and measurements.

Companies are generating outsized improvements. Mead Consulting clients that have embraced customer profitability have enjoyed significant improvements in performance both in revenue as well as profitability. To see more information on some of our client improvements, visit our client success stories page.

In work with our clients, we utilize proven methods designed to center the business around customer profitability. If you would like more information, please contact me.