“We love our customers!” Every business owner says it. But all customers aren’t created equal! This is why it is in your strategic interest to know which customers are really strengthening your bottom line and by how much. This can be seen with a customer profitability analysis.
If your business systems track individual customer purchases, and your accounting system has good cost accounting or decision support capabilities, determining individual customer profitability will be simple. If you have cost data for individual products, but not at the customer level, you can manually “marry” product-specific purchase history with the cost data to determine individual customer value.
For example, if a customer purchased 10 units of Product 1 and five units of Product 2 last year, and Product 1 had a margin of $100 and Product 2 had a margin of $500, the total margin generated by the customer would be $3,500. Be sure to include data from enough years within your customer profitability analysis to even out normal fluctuations in purchases.
Don’t maintain cost data? No worries; you can sort the good from the bad by reviewing customer purchase volume and average sale price. Often, many can supplement such data by general knowledge of the relative profitability of different products. Be sure that sales are net of any returns.
High marketing, handling, service or billing costs for individual customers or segments of customers can have a significant effect on their profitability even if they purchase high-margin products. If you use activity-based costing, your company will already have this information allocated accurately.
If you don’t track individual customers, you can still generalize this analysis to customer segments or products. For instance, if a distributor serves a specific group of customers, you can estimate the resources that are supporting that channel and its additional costs. Or, you can have individual departments track employees’ time by customer or product for a specific period.
There’s nothing wrong with loving your customers but it’s even more important to know them. How much value they’re contributing to your profitability from operating period to operating period? Contact us for help with your customer profitability analysis and breaking down the numbers.