Beyond Revenue & Costs: Calculating TRUE Customer Profitability

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Beyond Revenue & Costs: Calculating TRUE Customer Profitability

 

Part 2 in the Perfect Prospect Model series

 

Last week I introduced the concept of measuring customer value as a means of identifying and focusing on your BEST customers (and then using that knowledge to pursue the PERFECT prospects).

 

The wording (Customer Value) was quite intentional and I specifically didn’t say, “customer profitability.” Customer value is about understanding and considering all the variables that make some customers great and others a drain on your business. Customer profitability, on the other hand, is a financial metric in assessing customer value but, it’s only a piece of the puzzle.

 

Now, in the conversations I’ve had with companies over the years, many companies do calculate and measure customer profitability but, they typically look at the simplest of equations:

 

Basic Customer Profitability

 

 

 

This is a great place to start to but to understand TRUE customer profitability you’re going to have to work a bit harder and capture the indirect costs.

 

Let me give you an example. A company I used to work for some years ago had a habit of reporting gross customer profitability and the management were content to leave it at that. Being a numbers person myself and a techie, I wasn’t quite so convinced (that’s a nice way of saying that I was appalled) so I started to do some analysis to prove the case.

 

This particular business was built on high volume transactions with small margins. One of our customers – we’ll call them Drain-Yo-Money – did provide us with lots of business so, on the surface things looked good. However, this same company required individual paperwork, shipping, invoices and payments for every single transaction. They also wouldn’t accept invoices electronically so we had to mail them. What’s worse, we found ourselves having to constantly chase them for payment and they were often disputing agreed charges which led to even more personal involvement from the accounts department.

 

To illustrate the point, I began calculating an allocation that represented the cost of doing business with them. Without getting too accounting heavy at this point, here is roughly what it looked like:

 

 

 

Basic Customer Profitability: Looks good on paper

 

True Customer Profitability: Ugh! 

  • Invoicing Costs: # of Invoices Generated x £12.00
    There are many authority estimates on the cost of generating/processing customer invoices and the results indicate it runs somewhere between £8-£20 for paper-based systems. This takes into consideration things like employee time, paper/supplies, manual reconciliation, archiving, etc.
     

  • Dispute Processing: # of Disputes x £25.00
    As soon as a dispute was raised it required personal intervention. This amount estimated the cost of the staff’s time and began to factor in the delayed payment that typically resulted from the dispute.
     

  • Collections: # of Invoices Requiring Collection Follow-up x £40
    A portion of disputed invoices ended up with internal collections and required multiple calls to get payment.
     

  • Payment Processing: # of Payments Received x £5
    This customer paid each invoice individually requiring the A/R team to manually process and apply each one to the appropriate invoice.

 These are, of course, estimated numbers for illustration but they are quite close to my original calculations and they still don’t take into account any costs outside of finance (order taking, dealing with order questions/issues, account management, etc.). In short, we were LOSING MONEY every time we did business with this customer.

 

The best part of this story, however, is what led me to do the analysis in the first place. In this case, the sales rep had wanted to give the customer additional discounts in order to generate MORE sales. More sales that would have led to us losing even more money (and time) to this customer.

 

Examples of Indirect Cost Areas That Could Be Calculated in Customer Profitability:

 

  • Marketing (Events, Campaigns)

  • Sales Overhead

  • Legal (Contracts)

  • Administration

  • Accounts Receivable

  • Bank Fees/Processing

  • Support Services

  • Customer Education

  • Shipping (if not Direct)

  • Account Management

  • Systems Costs (CRM, ERP, etc.)

  • Overhead Staff & Building Costs

  • Etc.

 

 

You might be thinking that a simple, or even more extensive, profitability analysis should be enough to distinguish good customers from bad but I assure you that it’s not – especially in tech companies where I often work.

 

Sometimes, it is worth having a customer that is less profitable (and maybe even not profitable at all). It all depends on what other value you’re getting from them. In order to help the companies I work with to better build and benefit from Whole Company Selling programs, we assess not only the profitability of their customers but also other elements that combine to create a Perfect Prospect Model.

 

Subscribe/follow to learn more about each element of the Perfect Prospect Model.

 

Tune in next week for the third article in this series:

My Customer Loves Me, They Love Me Not: The Role of Loyalty in Customer Value

 

Julie Holmes is a sales & marketing advisor, speaker and Whole Company Selling leader. She works with B2B companies that want to sell more and increase their customer lifetime value by helping everyone in their organization understand and share their value with prospects and customers.

www.julieholmes.com

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