STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Illusion: “All Customers yield the same profit”. Different selling prices can be justified by variances in:  Customer service  Distribution costs  Product mix Customers have different demands in:  Pricing  Distribution  Sales support

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Customer Account Profitability: The total sales revenue generated from a customer (or customer group) LESS all the costs incurred in servicing that customer or group. The Marketing view of profitability:  There are NOT profitable PRODUCTS (products incur costs).  There are ONLY profitable CUSTOMERS (customer incur revenues). CAP focuses on profits generated by the customers; increases in sales revenues are NOT automatically associated with increases in profitability

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Major benefits of CAP come from:  Strategic Planning  Decision Making Knowledge of the relative profitability enables the company to focus its resources on areas that can generate profit and rationalize areas of unsatisfactory return. The Company can identify differences in profitability among customer groups and investigate the reasons. Knowing the effects on profits of any proposed change, gives relative strength.

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Retention of Customers Obtaining new customers is, usually, a substantial investment. Selling new products to existing customers is easier for well established suppliers, with quality image and loyal customers. Marks and Spencer expanded from clothing and food into furniture and financial services, using its loyal customer base. However, any product range expansion should fit into the set of customer expectations, in order to be readily accepted by existing customers.

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Maximizing Value of Existing Customers

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Retention of Customers (continued) In expanding product range, care should be taken not to annoy existing customers. If new products proves unacceptable, existing products may be affected. Thus, new products are not always associated with existing ones. Mars sells Mars, Milky Way, Twix, Bounty, Snickers etc. under the Mars label. Petfood business is sold under a different brand “Pedigree”

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Retention of Customers (continued) Maintaining existing customer has twofold benefits:  Selling and servicing existing customers becomes easier through time  Customers buy more frequently Understanding profitability of different customer groups, existing and potential, is critical to long-term decision making. CAP must be designed to assist this process.

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Customer Grouping Even if large customers deserve individual treatment, it is necessary to group customers for strategy reasons. Usually implemented groupings:  Geographical  Distribution Channel  Quality Characteristics (loyal, price-sensitive, low cost, high level of service) Consistent cost apportionment, will give valid results at least on relative profitability

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Geographical Customer Classifications

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Matrix Form of Customer Classifications

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Profitability Analysis Issues Variety in customer grouping adds complexity to the analysis of revenues and costs. At highest level, all divisional costs can be attributed directly to the customers. At micro, customer level, relatively few costs can be directly associated. Attributable cost: Could be avoided if product or function was discontinued entirely without changing the organization structure.

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Cost Directly Associated with Different Levels of Aggregation

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Profitability Analysis Issues (continued) Avoidable and incremental costs are separated from committed costs. Costs which are common to all the customers in any division, e.g. sales and marketing director’s salary, is a committed cost, unless all customers in the segment were discontinued. Apportionment of incremental costs should be at the appropriate level Distribution costs apportionment should be made at geographical division level. However, if customers with “central warehouse delivery” exist, these should be specifically considered. Customer groups with “private label” should absorb all costs related to the development of these products (design, packaging etc).

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Illustrative Customer Account Profitability Statement

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability CAP analysis should be a major element in strategic planning. It can highlight potential for new strategic thrusts or new channels of distributions. Directional Policy Matrix: Associates customer compatibility (factors taken into consideration by the customer when making a purchasing decision) with its business potential.

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Directional Policy Matrix

STRATEGIC MANAGEMENT ACCOUNTING Customer Account Profitability Prospective Customer: High potential, low compatibility. Developing a new customer involves an element of “investment”. This should be taken into account in the CAP analysis. New Customer: High potential, high compatibility. Increase the relative share of total business. Maintenance (existing) Customer: Continue to meet customer’s changing requirements. Directional policy matrix ensures that the right type of resources are dedicated to each category of customer and its profitability is evaluated appropriately.