You are on page 1of 25

PHD 9201: CROSS FUNCTIONAL ISSUES IN MANAGEMENT

CUSTOMER PROFITABILITY ANALYSIS


Submitted To:
Dr. Kulwinder Singh
Presented By:
Nupur Sachdeva (Marketing Management)
Sonali Sharma (Strategic Management)
ROAD MAP

• Introduction to Customer Profitability Analysis


(Meaning, Objective, How to conduct?)

• CPA and Marketing- Accounting Interface

• Why CPA?

• Challenges

• New directions
Introduction to CPA
 Customer Profitability Analysis (CPA) is a management accounting
method which allows businesses to determine the profitability of each
customer or segment of customers by attributing costs and revenues to
each customer/ segment separately.
 Customer Profitability (CP) is the net dollar contribution made by
individual customers to an organisation (Mulhern, 1999).
 It is “the difference between the revenues earned from and the costs
associated with the customer relationship during a specified period”
(Pfeifer et al., 2005).
 It is a retrospective method.
Objective

In 2007, Sprint- Nextel sent termination letters to a small percentage of their


customer base that had been over- using customer service, in some cases calling
hundreds of times per month. This was found by conducting CPA.

 To provide organisation management with the understanding of each


customer’s profitability.
 To identify/ distinguish between profitable and non- profitable customer
segments, and take necessary strategic actions.
 To shift organisation’s focus from product- mix to customer- mix.
How to conduct CPA?

1. Customer segmentation.
2. Calculation of annual revenue attributable to each segment.
3. Calculation of annual costs attributable to each segment.
4. Determining profitability/ Analysis of profitable and unprofitable
customer segments.
5. Developing strategies to maximize profits.
6. Reviewing the impact of new strategies on performance of customer
segments on timely basis.
How to conduct CPA?
Customer Segmentation-
 Individual level or aggregate level analysis.

 There are 2 approaches – demographic (geographic area, customer age,


gender, income level) or psychographic (customer values, attitudes,
interests).
Revenue attributable-
 Price paid by customers for a product/ service.

 Adjustments to the price paid in form of discounts, service fees, product


enhancement fees etc. must be included to determine true amount of
revenue generated by each customer, and aggregated for customer
segment.
Costs attributable-
 Direct costs attributable to product/ service; and indirect costs (customer
costs) like allocation of overheads, marketing, sales and distribution
expenses, hidden costs – quality control and inspection costs, order picking
and fulfillment etc. ………..ABC Analysis.
How to conduct CPA?
 Calculation of CPA amounts to an extensive Activity- based costing (ABC)
analysis/ exercise (Cooper and Kaplan, 1991; Foster and Gupta, 1994). The
steps in ABC analysis include- identification of cost pools, identification of
cost drivers for cost pools, and allocation of costs to cost objects (products/
service).
Determining Profitability-
 Comparing costs and revenues for each customer segment.

 Profitable customer = R > C

 According to Philip Kotler, “a profitable customer is a person, household, or


a company that overtime yields a revenue stream that exceeds by an
acceptable amount the company’s cost stream of attracting, selling and
servicing the customer”.
 2 Diagrammatic depictions at aggregate level– customer pyramid (Zeithaml
et al., 2001), and inverted Lorentz (Mulhern, 1999), or Stobachoff curve
(Storbacka, 1998).
Individual level- Figure shows R-C analysis for 2 customers with identical sales
profile (R) but different cost profiles. Customer B has higher sales costs,
service costs, and he has been assigned costs for credit. C > R, so B is
unprofitable customer.
Aggregate level- A customer pyramid is used to show tiers of customers within the
customer base. These tiers are based on revenues of customers. Large group of
lowest revenue customers is at the base of the pyramid and small group of highest
revenue customers is at apex. Figure shows a customer pyramid with 4 revenue tiers,
enriched by profitability data-
Aggregate level- Inverted Lorentz or Stobachoff curve is drawn by lining up all
customers on X- axis from highest absolute profitability to lowest (negative also),
while plotting cumulative profitability on Y axis. Figure shows 60% customers are
profitable, generating about 125% of total profits. Remaining 40% are unprofitable
and consume surplus generated by the first 60%. The position of apex and size of area
underneath the curve signify concentration and distribution of profits among
customers in customer base.
How to conduct CPA?

Developing strategies to increase profitability-


 By maximizing sales and services to profitable customers who are of lifetime value.

 By dealing with unprofitable customers using either of the 2 actions- Elimination-


(cease to supply unprofitable customers) or Reengineering- (Turning non-profitable
customers to profitable ones, by increasing revenues or decreasing costs. Eg-
charging additional fees for services, using differential pricing for these segments).
 Kaplan (1992) discusses three types of potentially unprofitable customers who
might be retained-
1. New and growing customers, who promise profitable business in the future.
2. Customers providing qualitative rather than financial benefits.
3. Customers providing increased capability because of their status as recognized
leaders in their markets or fields of expertise.

Review the impact of new strategies- On pricing, cost reduction, profit changes etc.
CPA AND THE MARKETING- ACCOUNTING INTERFACE
CP assesses financial value of a customer to a business. So, it is a fundamental
concept that links accounting and marketing. It has been debated both within the
marketing literature (eg- Helgensen, 2007; McManus and Guilding, 2008) and
accounting literature (eg- McManus and Guilding, 2002; Caker and Stromsten, 2010).
The research is limited in this area and no interdisciplinary evidence is available.

Gleaves et al., 2008


CP in Management Accounting Literature-
• It is a management accounting concept, and MA lost its way after becoming
subordinate to FA (Johnson and Kaplan, 1987). If MA had become dynamic and
responsive, on might assume CP would have achieved at least equal prominence to
product in the literature.
• Paradox: MA systems focus on products, departments, geographic regions’ and
very rarely on ‘customers’ (Foster et al., 1996).
• A major development in MA was introduction of ABC approach by Robert Kaplan.
MA treats CP as an extension to ABC, additional cost elements driven by customer
relationship.
CP in Marketing Literature-
• Mulhern (1999) identified 7 different ways CP was referred to in the literature
namely; lifetime value (Keane and Wang, 1995), CLV (Berger and Nasr, 1998),
customer valuation (Wyner, 1996), customer lifetime valuation, customer
relationship value (Wayland and Cole, 1997), customer equity (Blattberg and
Deighton, 1996), and customer profitability.
• CP has been confused with CLV and CE. No discrimination has been made in these
concepts.
• Marketers have been slow in promoting measurement of individual CV to the firm.
• There is a need for writers from both disciplines to come together and
produce joint work which focuses on customers' financial value to the firm
as a core concept of business management.
• Knowledge about which customers are profitable and unprofitable to
business can help in deciding about the budget to be allocated for
marketing activities. True profitability can be accessed.
Why CPA ?
• Each dollar of revenue does not contribute equally to
profit (Foster et al., 1997).
• Profitability depends not only on the unit cost but also on
many back end services like marketing, distribution and
customer service.

15
Differences in customer profitability can arise due to
either due to difference in revenue or difference in cost.

• Revenue differences: price charged per unit, selling


volume, product or service delivered.
• Cost differences: different customers use company
resources.

16
Focus of customer account profitability

• At lowest level- customers


• At aggregate level: grouping of customers
• Others- distribution channels.

17
What makes customer account profitability
distinctive?

• Entire value chain


• Multiple transactions
• Multiple products
• Customer specific cost
• Aggregate or narrow focus

18
Challenges
19

1. How to develop reliable customer revenue and cost figures?

Tracking customer revenue involves a variety of challenges-

• Different distribution channels or geographic regions


• Differing decentralization of purchasing
• Multiple names and codes
• Different credit and payment patterns
Challenges

Tracking customer cost involves a variety of challenges-

 Customers not as focal point


 Lack of source records
 Data needed for entire value chain
Challenges

2. How to recognize future downstream cost of customers?

Most systems pay less attention to capturing future cost of


today’s action.

 Environmental cost- challenge is in determining magnitude and

assigning this cost to appropriate time periods.

 Litigation cost: whether estimates be made and if made then

method of estimating.
Challenges

3. How to incorporate a multi-period horizon into analysis?

The importance of having long-term perspective is emphasized.


But there are different challenges like

 How to track profitability over time?

 How to prepare profitability budgets?


Challenges

4. How to recognize different drivers of customer cost ?

One of the assumption is that all costs are variable in the long
run with respect to chosen cost drivers.
Different approaches can be taken:
 Prepare separate analyses for cost drivers and their rates in short
run and long run
 Prepare customer cost hierarchies that recognize different levels
of cost drivers.
Directions

• Supporting strategic decisions


• Valuing intangible assets
• Analyzing customer retention rates

24
RESEARCH PAPERS

 Erik M. van Raaij, (2005) "The strategic value of customer profitability


analysis", Marketing Intelligence & Planning, Vol. 23 Issue: 4, pp.372-381.
 Francis J. Mulhern, 1999, 'Customer profitability analysis: Measurement,
concentration, and research directions', Journal of Interactive Marketing, vol. 13,
no. 1, pp. 25-40
 Malcolm Smith, Shane Dikolli, (1995) "Customer profitability analysis:: an
activity‐based costing approach", Managerial Auditing Journal, Vol. 10 Issue: 7,
pp.3-7.
 Mulhern, F.J. (1999), “Customer profitability analysis: measurement, concentration,
and research directions”, Journal of Interactive Marketing, Vol. 13 No. 1, pp. 25-40.
 Robin Gleaves , Jamie Burton , Jan Kitshoff , Ken Bates & Mark Whittington (2008)
Accounting is from Mars, marketing is from Venus: establishing common ground for
the concept of customer profitability, Journal of Marketing Management, 24:7-8,
825-845.