Measuring Customer Profitability

Customer profitability is quite simply defined as the difference between the revenue earned from and the total cost associated with the generation of that revenue by a customer over a particular time frame. Generally, a small percentage of your top customers account for a large portion of your net profits. On the contrary, there are a percentage of customers who typically cost more to serve than the revenue that is generated by that customer. These unprofitable customers detract from the overall profitability of a company. Profit winners and losers are a result of variation in products purchased, revenues generated and the actual cost it takes to serve an individual customer. Armed with knowledge on customer profitability, a company can benefit from knowing precisely which customers create value, which take away value and what the difference between the two is. This information is critical not only to affect the performance of your business today, but to accurately target and retain profitable customers in the future.

While the definition above is simple to understand there is often a problem in determining which customers fit into which categories Most management accounting systems focus on product or service-line costs due to regulatory accounting requirements e.g. those requirements of financial institutions, investors and reporting agencies. But for expenses that reside below the gross margin level, including costs for sales, marketing and product/service distribution channels, accounting rules require that they be recognized during the month in which they were incurred. As such these costs cannot be capitalized and placed on the balance sheet in the same way that product inventories can. Accountants refer to these as “period” costs. However, to analyze customer profitability, internal management reporting needs to apply the same costing principles to channel and customer types. Because this type of non-traditional cost accounting does not occur with all companies, customer and product line efficiency is not measured as frequently as it should.

MainStream is ready to guide your organization through this process so that your company has visibility and assignable costs to your customers. Product line and customer based efficiency is a critical component of long-term value creation.