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Managing Customer Profitability 6 Managing Customer Profitability

Customer Profitability Analysis Using ABC to determine the activities, costs, and profit associated with serving specific customers. For Example Customer makes frequent order changes. Customer needs special parts. Customer is difficult to please. For various reasons, some customers are less profitable than others.

Customer Profitability Analysis Once we know which customers are the least profitable, we can modify our relationship to improve profitability. We’ll send a team to your plant next week and help you set up an ordering system that gives us more lead time. I hate to do this, but we just can’t continue doing business with you. If you ask for fewer changes, we can charge you less!

Customer Profitability Analysis There are two primary steps: Identify Effective and Ineffective Customer-Related Activities Measure Customer Profitibility

Measuring Customer Profitability Studies have shown that only 20% of a company’s customers contribute to profits. The remaining 80% generate losses. Profit can be measured by: Region Product Line

Measuring Customer Profitability - Example Assume Koala Camp Gear looks at 5 of its customers. Bar graphs are common analytical tools. Customer Profitability Customer #

Measuring Customer Profitability - Example Note that attention should be focused on customers #102 and #114. Question: Why are these two customers not profitable? Customer Profitability Customer #

Measuring Customer Profitability - Example Comparing the customer-related costs for each customer can reveal helpful insights. We Investigate and find. . . For Customer #102, costs of order processing, engineering/design changes, and special handling are above normal. For Customer #114, the cost of special packaging is 4× the norm. The cost or special handling is 6× the norm.

Identify Effective & Ineffective Customer-Related Activities Study closely all the customer-related activities that drive cost. Typical Customer-Related Activities Include: Processing Orders Sales Contacts Sales Visits Processing Shipments Billing Engineering/Design Changes Special Packaging Special Handling

Customer Profitability Analysis HealthWave, Inc. Which of these customer groups is the most profitable for HealthWave? HealthWave, Inc. sells non-prescription pharmaceuticals to three major customer types: Pharmacies Groceries Herbal Therapists

Sales Pattern Analysis Exh. 6.5 Sales Pattern Analysis HealthWave, Inc. At this point, it would appear that Pharmacies provide the highest contribution margin ratio. Let’s examine further.

Sales & Admin Cost Analysis HealthWave, Inc. Ordering Costs Selling Costs Marketing Costs Distribution Costs General & Administrative Costs

Selling Cost Analysis HealthWave, Inc. Exh. 6.6 Selling Cost Analysis HealthWave, Inc. HealthWave sells its products using sales personnel in the field and telephone ordering. A summary of those cost appear below. Note that Herbal Therapists appear to have the lowest selling costs.

Marketing Cost Analysis Exh. 6.7 Marketing Cost Analysis HealthWave, Inc. Marketing costs include personnel, databases, equipment, and facilities. HealthWave’s costs can be broken down into Marketing Management Costs, Promotion and Incentive Costs, Advertising Costs, and Catalogue Development Costs. Again, Herbal Therapists have the lowest marketing cost.

Distribution Costs Analysis Exh. 6.8 Distribution Costs Analysis HealthWave, Inc. Distribution costs include packing, shipping and delivering products or services to customers. HealthWave delivers goods using its own trucks and a private delivery service, PackageXpress. This time, Grocery customers have the lowest distribution cost.

Again, Herbal Therapists have the lowest marketing cost. Exh. 6.10 G & A Costs Analysis HealthWave, Inc. Typically, general and administrative costs are not directly customer-related. These costs can often be difficult to trace to specific customers. HealthWave breaks them into two broad categories; Customer Service and Manufacturing Support Again, Herbal Therapists have the lowest marketing cost.

Customer Profitability Analysis Exh. 6.11 Customer Profitability Analysis HealthWave, Inc. Finally, we put all the information together to determine which customer-type is the most profitable. The Groceries appear to be the most profitable customer.

Common-Sized Profit Statements HealthWave, Inc. To better compare different sets of data, the dollar amounts can be recast as a percentage of revenues.

What To Do? HealthWave, Inc. The Pharmacy customers are not contributing to HealthWave’s profitability. What are the options? Decrease operating costs Do Nothing Increase efficiency of serving pharmacy customers Drop pharmacy customers

End of Chapter 6 Common-size THIS!