An Overview on Customer Profitability

by Hans-Gerlach Woudboer

The customer may always be right, according to the old adage. But, here is a not- so-old adage that is just as true: The customer may not always be profitable.

The notion of abandoning customers may seem counter intuitive but in many industries analyzing customer behavior and responding with strategies to make them as profitable as possible, especially for the long run, is essential to a company’s long term success.

The Situation

Companies across industries are reorganizing and restructuring their businesses to be less product- oriented and more customer-focused. Product-focused companies prune unprofitable products. Now, they also are taking a look at customer profitability. How do you define an unprofitable customer? What is the process for turning this into a profitable customer so that you only abandon the customer as a last resort? More and more companies are asking these questions.

In most markets about 20% of the customers deliver 80% of the profitability. The remaining 80% do not contribute significant additional profit. In addition, some customers erode profits. This is probably true in 80% of all scenarios.

The Question: How do we obtain true customer profitability?

We need a business model that describes, in sufficient detail, what part of the business we should examine in order to understand real customer profitability. What are the variables we need to change to improve and to grow our customer base in an optimal way?

The model is a reflection of the important relationships between supplies, resources and assets, capital investment, the processes used to create products, customer services and supply costs to the customers and if possible, as a next step, as a function of time. Consequently, we should be able to predict which customers need what level of service for an optimum total Customer Lifetime Value.

RapidBusinessModeling has developed a solution that combines the concepts of advanced Activity Based Costing with a new type kind of technology-the underlying proprietary engine for multidimensional business modeling. This enables the user to build any model based on spreadsheets, in order to feed in the data, and assign cost via multi-dimensional drivers to multi-dimensional objects. RapidBusinessModeling can help you create a Business Model describing which customer falls into which segment of profitability. We don’t expect you to learn complicated modeling tools; rather you exploit what is available – spreadsheets! Our product turns these spreadsheets into the desired model with ease enabling you to carry out decisions to achieve sustainable growth for your company.

Advanced Activity Based Costing approach with RapidBusinessModeling

In order to assign cost to activities, products and customers we use either the so called Rate- based Activity Based Costing or the Time-Driven Activity Based Costing methodology. Ideally we combine both for an optimal model. Where advanced stands for the capability to use drivers based on equations.

During the interviewing process one learns about the many repetitive tasks or activities. For repetitive tasks it is best to break down the activity into single components and factor in the time or duration it takes to perform each component based on transactions. That way, precise data based on transaction data are created, which allows to update the business model very frequently. Time-Driven Activity Based Costing -TDABC- should always be the approach for the repetitive tasks. Advantages of TDABC are manifold:

  • Greater acceptance in the long run as traditional Activity Based Costing becomes invalid if re- interviewing is not part of the ongoing process.
  • Easy to update after redesign of tasks – just change the duration of the modified task.
  • Can be used on an ongoing basis for tactical action and as well as strategic functions.

Calculations can also be based on variables vs. numbers. A model can become a set of equations describing what the customer profit is based upon. This can be used for multi-dimensional “what if” calculation scenario simulation.

Profit Improvement Potential Analysis

A profit potential improvement analysis is carried out that provides a sort of internal benchmarking. As a result, cost and revenue-potential are shown in a Pareto style, enabling fast tracking the highest potential opportunities. Each opportunity could be a new task for a change team like the 6 Sigma or TQM teams joining forces with marketing and sales.

How to finally improve / change the Customer Profitability:

From an organizational perspective what needs to occur so that an unprofitable customer has a chance to become a profitable customer? Before organizational or business related changes could occur, the implications of those changes must be fully understood. This is best handled through the RapidBusinessModeling solutions. Using what if scenarios one can simulate how the particular customer or the organization will be impacted by the change. The change team headed by a senior member of the sales or marketing organization within the company has to understand the impact of potential changes.

Some customers will remain unprofitable despite all your potential cost reductions. If that is the case than the right price change must occur or there needs to be an adjustment in service! Some of these customers might accept this change. Often, customers in the unprofitable segment are in a very dependent situation. You might find out that you own the monopoly of what and how you supply your customers.

Hans-Gerlach Woudboer
Owner and Founder of RapidBusinessModeling.

Chemical engineer, earned his Master degree at the Aachen University of Technology, Germany. He has been in a consulting role since 1999 – dedicated to customer profitability improvement – as part of 27 year with ExxonMobil Chemical in various technical and managerial positions in manufacturing, business and marketing.