Managing customers for profits

If two customers purchase from the same company the exact mix of products and services at the exact same prices during the exact same time period, would both customers be equally profitable? More likely than not.

Some customers are extremely nagging and demanding special services, change their delivery requirements or ask to expedite the order, whereas some customers hardly demand anything. Although it looks like both the customers are equally profitable because they are generating same revenue for the company and the product cost is also the same, both the customers are not equally profitable. Therefore it is essential for every seller to do a customer profitability analysis and find out which customer is more profitable.

It is important to identify the most profitable customers and manage each customer's cost to serve to a lower level. A seller may have to raise price for demanders or add charge for high cost to serve customers. One may have to come to a decision of abandoning product, services or even customers.

A customer profitability analysis traces and reports customer revenues, costs and value that is important to assess the type of customer. It is an evaluation process that focuses on assigning costs and revenues to segments of the customer base, instead of assigning revenues and costs to the actual products.

Better efficiency

Many businesses use a customer profitability analysis as a means of streamlining processes so that they provide the highest degree of efficiency and return, while generating the lowest degree of cost. As per the matrix created by Gary Cokins of SAS Institute, a customer who is low-cost to serve and gives high product margin is of a champion category and every effort must be made to retain that customer. Efforts must be made to gain more volume of sales from champions.

Demanders in the matrix are the customers who are very demanding but also contribute to high profit margin. The strategy for these customers should be to retain them and if required, charge extra for cost to serve. In doing customer profitability analysis, a company has to ascertain whether the demanders are demanding service because they are available for free or whether they require those services. If they require those services even if they are charged , then the company should go ahead with it. In fact, companies should welcome such demanders. If the analysis makes it clear that the company is depending on two or three large customers to generate half or more of the its business volume, then steps are usually taken to diversify and expand the client base, often by attracting more small to mid-sized customers. It is risky for the business if a large customer withdraws as the company will lose a major chunk of the market share.

Cost-revenue study

Customer profitability analysis is done by doing a detailed analysis of customer revenue and customer cost. Differences in revenues arise mainly because of differences in price per unit charged to customers due to discounts provided. Differences in customer costs arise from the way customers use the company's resources. Most of this cost difference lies in the usage of downstream functions such as customer service, marketing, and distribution.

For example, some customers require a lot of customer service time, while others require none at all. There are certain costs such as customer sustaining costs, order processing costs, invoicing costs and sales return costs. Customers who order in bulk quantity are less costly as compared to customers who order more in small quantities. Collection costs become high for late payments as well as the company loses money in interest, technically termed as cost of capital.

Management has to be careful in doing away with the customers who are less profitable. They must see whether these less profitable customers are potential long-run profitable customers.

Also, elimination of a less profitable customer who is sharing a distribution channel cost or logistic cost may not be wise as these fixed overhead costs will have to be now borne by the existing customers. The company should not miss the fact that a portion of overhead costs is borne by every customer.

(The author is Professor, Finance, Institute of Management Technology, Ghaziabad.)

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