Customer Profitability

Customer Profitability As A Value Creation Lever

Many strategic pricing programs incorporate an assessment of customer profitability into their approach.  It’s important, however, to ensure you are approaching this from the perspective of sustainable growth vs. short term improvement tactics. We’re going to share some of overarching principles of customer profitability analysis that we use in our work along with some deeper pieces we’ve written about the topic.

Take a look at the articles below – we will be exploring this topic from several different angles.

Getting Run Over By a “Paid For” Truck

On By In Customer Profitability, Distributor Pricing, Pricing Analytics

As a cautionary tale, we present to you a Vegas story in which a janitorial supplies distributor’s best price was crushed by a food service competitor who had already covered their cost to serve.

In your own business, where are you at risk? What kinds of competitive barriers can you throw up (product or service) to defend your market position? Playing offense, can you use this approach to take share within an account?

Because there’s no guarantee that what happens in Vegas, stays in Vegas

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Strategic Pricing: 9 Ways To Improve Profit Margin

On By In Customer Profitability, Distributor Pricing, Margin Improvement, Pricing Analytics, Pricing Consulting, Private Equity, Product Profitability, Project Profitability, Turnaround Strategy

True Strategic Pricing isn’t about simply charging more money In fact, that’s a very risky long term value creation lever. The market eventually figures out what you’re doing.

Pricing leaders know that you need to be as good at creating value as your are at claiming it.

For a sustainable margin lift, look at these case studies exploring how to reshape the value you offer customers – and cost of delivering that value – to create a competitive advantage.

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Using Customer Profitability For Good vs. Evil

On By In Customer Profitability, Leading Change, Margin Improvement, Private Equity

The worst thing you can do with your new customer profitability reporting is sally forth to fire the unprofitable customers

Instead, look at this as an opportunity to reshape the focus of your selling team. Which accounts do we want? Can we fix our profitability issues by growing within an account? Are there product mix or policy enforcement opportunities which can improve the profitability of the business we already enjoy?

Or are we selling services the customer doesn’t really need (or want)? Giving us a chance to simplify our offering before we’re removed by a low-cost competitor.

Sometimes the best way to improve customer profitability is to simply focus on value…

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Customer Profitability: Specific Analytical Challenges

One key question which arises early in the analysis is should you value customers based on “actual” events or “pro-forma” performance. The latter involves taking “luck-driven” events and allocating them back across a larger group of customers. While it is often simpler to assign all customer costs to specific customers, this can easily lead to over or under valuing customer relationships. The first challenge you need to address is randomness: how much of the difference between two customers or orders is driven by chance? This is particularly acute in B2B customer profitability work (especially for a manufacturer or wholesale distributor), since a handful of customers placing large orders tend to drive your business at a local level. Small shifts in the mix of products purchased or the timing of the orders can swing your numbers all over the place… but don’t represent real changes. Next month’s results will be equally random. The same challenge applies if you’re looking at large – but contingent – charges against a customer P&L. For example: damages and penalty charges. Customer specific damage claims aren’t necessarily a sign of a bad customer: they need to be balanced out across a broader universe of account. The same logic applies to bad debt expense: merely charging it back to an account actually over-allocated the cost to a bad customer and ignores the fact you accepted that risk the instant you took the order. This type of cost needs to be allocated across customer segments (similar types of customers with similar credit risks). The final challenge of calculating customer profitability lies in correctly valuing activity removed from the system. It’s important to understand if you’re taking out fixed cost or variable, especially if your variable costs are a step function (holding them fixed across an interval). It’s hard to remove half of a truck. There may also be shifts in your cost of goods sold due to losing purchase discounts and vendor incentives

Using Lifetime Customer Value To Prioritize Sales Time

While one of the most powerful applications of lifetime customer value analysis is prioritizing sales and marketing time, this is often met with resistance from the selling team. It’s important to position the roll-out to build the credibility of the tool. Directly addressing unprofitable customers is often counter-productive. While analytically valid, it immediately triggers an argument about the accounting standards underneath the system. The cost of which is your best sellers will take their eye off the customer to learn about costing. A better approach is to identify untapped opportunities and highlight higher profit per hour uses of time. Take your most profitable accounts and identify similar prospects. Explain how these accounts are worth a substantially higher return per hour of selling time. Along the same lines, use analytics to identify gaps in the product portfolio for highly profitable accounts and provide a list of them to your sales team. This is another potentially easy win.

Customer Profitability Analysis for Board Stakeholders

Turning to your other set of stakeholders, your board members and shareholders (or private equity firm). Customer profitability analytics can provide an excellent way of justifying aggressive pricing tests. For example, you should consider raising prices on unprofitable customers faster than other accounts. In small amounts this represents a win-win outcome. Either the customer accepts the increase (fixing your profit issue) or they exit the business (opening up capacity for regular business). This needs to be balanced against the organization’s ability to acquire new business. Interested in a deeper discussion of how customer profitability analysis can help your business. Consider asking about our pricing consulting services.