CUSTOMER CUSTOMER PROFITABILITY PROFITABILITY

ANALYSISANALYSIS

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Group 3Group 3

Flow of PresentationFlow of Presentation

Definition Of CPADefinition Of CPA CRMCRM Importance of CPA in CRMImportance of CPA in CRM A Hypothetical SituationA Hypothetical Situation Determining Customer ProfitabilityDetermining Customer Profitability The CPA ProcessThe CPA Process From ABC to CPAFrom ABC to CPA ConclusionConclusion

DefinitionDefinition Analysis that assigns revenues and costs to major customers Analysis that assigns revenues and costs to major customers

or groups of customers rather than to organizational units, or groups of customers rather than to organizational units, products, or other objects. The results may direct products, or other objects. The results may direct organizational resources towards more profitable uses. organizational resources towards more profitable uses.

It is an application of segmented reporting in which a It is an application of segmented reporting in which a customer group is treated as a segment. It is especially customer group is treated as a segment. It is especially helpful when combined with an activity-based costing helpful when combined with an activity-based costing approach that determines which activities are performed for approach that determines which activities are performed for each group and assigns costs based on appropriate drivers.each group and assigns costs based on appropriate drivers.

Example : Activities, their drivers, and their costs may be Example : Activities, their drivers, and their costs may be classified as order level, customer level, channel level, classified as order level, customer level, channel level, market level, or enterprise level.market level, or enterprise level.

Contd…Contd… In other words, In other words, Customer profitability analysisCustomer profitability analysis combines combines

analysis of manufacturing costs based on customer analysis of manufacturing costs based on customer requirements with analysis of the costs of serving requirements with analysis of the costs of serving customers through different channels.customers through different channels.

It takes as its starting premise, the viewpoint that the It takes as its starting premise, the viewpoint that the

economic value of customers varies, and that the variation economic value of customers varies, and that the variation is due to a combination of economic forces and behaviors is due to a combination of economic forces and behaviors on the customer side as well as within the client (supplier) on the customer side as well as within the client (supplier) organization. It is crucial to understand the differences in organization. It is crucial to understand the differences in customer profitabilityand the drivers of that customer profitabilityand the drivers of that profitabilityto make sound business decisionsprofitabilityto make sound business decisions

CRMCRM

CRM (Customer Relationship CRM (Customer Relationship Management) is an information Management) is an information industry term for methodologies, industry term for methodologies, software, and usually Internet software, and usually Internet capabilities that help an capabilities that help an enterpriseenterprise manage customer relationships in an manage customer relationships in an organized way. organized way.

Importance of CPA in CRMImportance of CPA in CRM Unless you are trying to penetrate new markets or are Unless you are trying to penetrate new markets or are

operating a loss-leader strategy, most of your business operating a loss-leader strategy, most of your business transactions should be profitable.transactions should be profitable.

It would indeed be foolish to sell your products for It would indeed be foolish to sell your products for less than it costs you to produce and market them. less than it costs you to produce and market them. CRM, however, is not about product profitability but CRM, however, is not about product profitability but rather the development of relationships with your rather the development of relationships with your customers in order to meet their needs and make a customers in order to meet their needs and make a profit overall. profit overall.

The challenge of CPA is, therefore, the tracing of The challenge of CPA is, therefore, the tracing of both revenues and costs back to each individual both revenues and costs back to each individual customer in order to evaluate their profitability.customer in order to evaluate their profitability.

A HYPOTHETICAL SITUATIONA HYPOTHETICAL SITUATION Now, Consider two different customers of a fictitious Now, Consider two different customers of a fictitious

company. They both have purchased the same volume company. They both have purchased the same volume for total revenues of £5,000 each. Gross margin for for total revenues of £5,000 each. Gross margin for the company on each transaction is £1,000.the company on each transaction is £1,000.

However, while the first customer has made no special However, while the first customer has made no special product or process requests, customer 2 has required product or process requests, customer 2 has required that the product be customised with special that the product be customised with special overprinting on the packaging and delivered just in overprinting on the packaging and delivered just in time to three different sites. In addition, he has asked time to three different sites. In addition, he has asked the company to provide special point of sale the company to provide special point of sale promotional materials, special sale or return promotional materials, special sale or return conditions and a discount. conditions and a discount.

Contd…Contd…

These specific requirements have meant These specific requirements have meant that the sales person responsible for that that the sales person responsible for that account has had to spend twice as much account has had to spend twice as much time negotiating these terms. Taking all time negotiating these terms. Taking all these additional costs into account, the these additional costs into account, the margin the company makes on customer margin the company makes on customer 2 is only £250.2 is only £250.

Thus, All things being equal, customer 1 Thus, All things being equal, customer 1 is four times more profitable than is four times more profitable than customer 2.customer 2.

Determining Customer Determining Customer ProfitabilityProfitability

Customer RevenueCustomer Revenue Revenue is generally the most Revenue is generally the most

straightforward category to determine. straightforward category to determine. Companies usually have information Companies usually have information that captures sales/revenue associated that captures sales/revenue associated with specific customers. with specific customers.

Other information needed may include Other information needed may include customercustomer discounts, rebates and discounts, rebates and other deductions. other deductions.

Contd…Contd… Customer CostsCustomer Costs

Customer costs are calculated the same way as activity Customer costs are calculated the same way as activity costs are calculated. costs are calculated. Each activity that is mapped to a Each activity that is mapped to a customer brings along an associated activity cost. The customer brings along an associated activity cost. The accumulation of those activity costs determines the accumulation of those activity costs determines the customer cost. As with resource costs, the activity cost customer cost. As with resource costs, the activity cost mapped to a customer is based upon the value of that mapped to a customer is based upon the value of that driver as a perdriver as a percentage of the total driverscentage of the total drivers

Example : Example : CConsider the mapping of the activity “Provide Customer onsider the mapping of the activity “Provide Customer

Support over the Telephone,” which has a cost of Support over the Telephone,” which has a cost of $5,000,000 to customer A and customer B.$5,000,000 to customer A and customer B.

Contd…Contd…

Customer A receives 1500 minutes of support, Customer A receives 1500 minutes of support, while customer B receives 3500 minutes of while customer B receives 3500 minutes of support during the same period.support during the same period.

In this example, 30% (1500/5000) of the In this example, 30% (1500/5000) of the $5,000,000 will go to customer A, and 70% $5,000,000 will go to customer A, and 70% (3500/5000) of the $5,000,000 will go to (3500/5000) of the $5,000,000 will go to customer B. This means that you spent customer B. This means that you spent $1,500,000 in this period to provide customer $1,500,000 in this period to provide customer support over the telephone to customer A. support over the telephone to customer A.

The CPA processThe CPA process

Start with the following data:Start with the following data:

Revenues per customer (including Revenues per customer (including discounts or rebates, sales discounts or rebates, sales commissions, or credit notes);commissions, or credit notes);

Total business unit costs, Total business unit costs, especially overheads.especially overheads.

The CPA process then takes four The CPA process then takes four steps.steps.

CONTD…CONTD…

Step 1Step 1 For each customer subtract their direct costs (cost of goods For each customer subtract their direct costs (cost of goods

or cost of sales) in order to identify their contribution or cost of sales) in order to identify their contribution margin.margin.

Step 2Step 2 Next, understand what you do to meet your customers’ Next, understand what you do to meet your customers’

needs i.e. map the various activities that go into serving needs i.e. map the various activities that go into serving them. The best way to do this is to develop a simple process them. The best way to do this is to develop a simple process flow diagram representing customer interactions and flow diagram representing customer interactions and identifying where the cost elements lie. At this stage it might identifying where the cost elements lie. At this stage it might be useful for you to map your customers’ activity cycle and be useful for you to map your customers’ activity cycle and develop some form of graphical checklist . Additionally, the develop some form of graphical checklist . Additionally, the sequence of customer interactions might vary depending on sequence of customer interactions might vary depending on the nature of your business.the nature of your business.

CONTD…CONTD… At this stage, using estimates is acceptable. Much of the At this stage, using estimates is acceptable. Much of the

analysis becomes easier once you have gained a clear analysis becomes easier once you have gained a clear understanding of your basic customer interaction understanding of your basic customer interaction processes and how many customers you have.processes and how many customers you have.

Step 3Step 3 For each cost group (sales force, call centre, etc.) For each cost group (sales force, call centre, etc.)

identify what activities drive costs. Begin by allocating identify what activities drive costs. Begin by allocating those costs that are simple to categorize and that you those costs that are simple to categorize and that you can easily relate to specific activities. Use your can easily relate to specific activities. Use your judgment to allocate those costs that are not as easily judgment to allocate those costs that are not as easily traced. traced.

CONTD…CONTD…

Step 4Step 4 Finally, just subtract the overhead Finally, just subtract the overhead

costs that you have just computed in costs that you have just computed in step 3 from the contribution margin step 3 from the contribution margin of step 1.of step 1.

From ABC to CPA

CPA relates to activity-based costing by linking operational activities (and their costs) with individual customers. Starting with ABC will therefore, provide you with key insights into a customer’s profitability while going some way in explaining why different customers have different levels of profitability.

CONTD…CONTD… Conventional Costing Simplistic allocation of costs

Costs --Consumed by-- Products

Allocation: Costs are allocated to products based on assumed

linkages or convenient alternatives such as direct labour hours

Activity-Based Costing Traces costs based on cause and effect

Costs-- Consumed by Activities—Consumed by products

CONTD…CONTD…

Resource Cost Drivers:Costs are assigned in activities based on

usage patterns

Activity Cost Drivers:

Activity Costs are assigned to products based on usage patterns

ConclusionConclusion Customer Customer cost and cost and customer profitabilitycustomer profitability is is

critical for a company today. Knowing your total critical for a company today. Knowing your total costs for particular processes and activities costs for particular processes and activities allows you to focus on reducing and controlling allows you to focus on reducing and controlling them. Knowing costs for a specific them. Knowing costs for a specific customercustomer allows you to reduce, chang or charge for allows you to reduce, chang or charge for activities/services provided to them. activities/services provided to them.

The determination of The determination of customercustomer costs and costs and profitabilityprofitability should be performed using activity should be performed using activity based costing techniques. Although it requiresbased costing techniques. Although it requires the availability of the availability of customercustomer-related data, the -related data, the calculation is straightforward. calculation is straightforward.

CONTD…CONTD…

Although many companies do Although many companies do not have not have customercustomer cost and cost and profitabilityprofitability systems, a systems, a growing number are beginning growing number are beginning to develop them and it is to develop them and it is imperative that you develop the imperative that you develop the information before your information before your competitors do. competitors do.

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