Customer Profitibility Analysis and types of customer-related costs
Customer profitability analysis
Businesses wish to attract and retain customers that produce profitable sales orders. It is, therefore, important to know whether a particular customer, or type of customer, generates profits for the business. Modern businesses are likely to find that much of the cost incurred is not related to the products sold but to the selling and distribution costs associated with those sales. This has led to a shift in emphasis from product profitability to customer profitability.
Types of customer related costs to be analyzed for successful CPA
Customer profitability analysis (CPA) assesses the profitability of each customer or type of customer. In order for CPA to be undertaken, the total costs associated with selling and distributing goods or services to particular customers must be identified. These include the cost of;
Handling orders from the customer. This covers the costs involved with receiving the order and activities relating to it up to the point where the goods are dispatched, or the service rendered, including the costs of raising invoices and other accounting work.
Visiting the customer by the business’s sales staff. Many businesses have a member of staff visit customers, perhaps to take orders, but often to keep the customer up to date with the latest developments in the business’s products.
Delivering goods to the customer, using either a delivery service provided by another business, or the business’s own transport. Naturally, the distance involved and the size and fragility of the goods will have an effect on this cost.
Inventories holding. Some customers may require a particular level of inventories to be held by the business: for example, a customer operating a ‘just-in-time’ raw material delivery policy. This can require deliveries to be made frequently and at short notice, in effect putting pressure on the supplier to hold higher inventories levels.
Offering Credit. The business will have to finance any credit allowed to its customers. This could vary from customer to customer, depending on how promptly they pay. l After-sales support. Technical assistance or servicing may be offered as part of the sales agreement.
These customer-related costs are probably best determined using an activity-based costing approach to cost allocation. This means that, once customer-related costs are identified, cost drivers must be established and appropriate cost driver rates deduced.
Once customer-related costs are derived, a CPA statement, which is essentially an abbreviated income statement, can be produced for each customer and/or type of customer. The CPA statement will show the relevant sales revenues and, in addition to the customer-related costs identified earlier, will include the basic cost of creating or buying-in the goods or services supplied (that is, cost of goods sold) and any general selling and administration costs of the business. Example 9.1 illustrates a CPA statement.
Once customer-related costs are derived, a CPA statement, which is essentially an abbreviated income statement, can be produced for each customer and/or type of customer. The CPA statement will show the relevant sales revenues and, in addition to the customer-related costs identified earlier, will include the basic cost of creating or buying-in the goods or services supplied (that is, cost of goods sold) and any general selling and administration costs of the business. Example below illustrates a CPA statement.
In practice, it is often the case that a small proportion of customers generate a large proportion of total profit. Where this occurs, the business may decide to focus its marketing and customer support efforts on these customers. The less profitable customers may then be targeted for price increases or, perhaps, reduced customer support, as we saw in A plc above.
Where a business has many customers, the analysis of individual customers’ profitability may not be feasible. In such a situation, it may be better to categorise customers according to particular attributes and then to assess the profitability of each category. Thus, the support services division of one large computer business divides its customers into three categories based on technical capabilities, how they use the product and the type of service contract they have. However, identifying appropriate categories for customers can sometimes be difficult.
Real World shown in diagram below provides some impression of the extent and frequency to which customer profitability is assessed in practice.