1. Hilton • Maher • Selto

2. Managing Customer Profitability6
Managing Customer Profitability

3. 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.

4. 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!

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

6. 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

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

8. 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 #

9. 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.

10. 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

11. 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

12. 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.

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

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

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

20. 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

21. End of Chapter 6
Common-size THIS!