OPEN Insight: Assessing Customer Profitability

It’s a standard business adage that it is easier (and less expensive) to sell to a current customer than to acquire a new one. Determining which of your customers is most valuable to your business – not just now but over the lifetime of your relationship – can give you a leg up in retaining them, selling themmore and finding other customers like them.

To be successful, you must provide value to your customers, but the reverse is also true – your customers must provide value to you. understanding customer profitability – i.e. which customers generate profit for you and which customers may actually be costing you money – can be critical to the long term success of your business.  Knowing how each customer (or if you have a lot of customers, each customer segment) affects your company’s bottom line can help you determine:  

Which customers to focus on

When you know that a customer is profitable, you can justify investing more to enhance the relationship (and ensure you don’t lose the customer to a competitor). 

How to sell best customers more

Dedicating your efforts to your most profitable customers can help you identify cross-sell and up-sell opportunities that can further cement your relationship. 

How to find more best customers

Once you know the profile of your best customer, you can focus your sales and marketing efforts on prospects that match those characteristics, helping you get more impact from your prospecting dollars.

How to improve profitability among less attractive customers 

It’s expensive to acquire a new customer, so it makes sense to do whatever you can to make an existing customer more profitable. when you understand which of your customers are less profitable and why, you may be able to make adjustments to your marketing, sales, service and/or fulfillment processes to make the relationship work better for you. 

You may not always be able to turn an undesirable customer relationship around , but getting a handle on customer profitability can help you avoid a common business pitfall: spending time, energy and money on low-return customers.

Customer profitability analysis is especially important to service-oriented industries, where the cost of servicing different customers can vary dramatically. If a higher-than-expected level of servicing is required, profitability can take a huge hit. Similarly, manufacturing companies need to assess if the production and operating costs required to meet a customer’s demand is being orevenue generated by that customer.  

Customer Profitability Analysis

Calculating customer profitability can be daunting, which is partly why many companies avoid even attempting it. rigorous, in-depth customer profitability analysis requires detailed information about how your company’s costs should be allocated to each customer, as well as your best guess as to how much that customer will spend with you over time. 

Because it is expensive and time-consuming, many companies don’t track or allocate costs by customer. However, a less rigorous but still useful analysis can be done at a higher level. all it takes is estimating time and cost allocations based on each customer or customer segment.

Putting your analysis into action

Once you’ve estimated customer profitability, you can assess your business model to identify areas for improvement, focusing on the areas where costs are driving down profitability. Here are some key questions to consider as you assess your cost structure and ways to improve profitability: 

— Which customer acquisition methods have been most effective at pulling in the most profitable customers? Does it make sense to reallocat acquisition dollars? are there some channels or customer acquisition vehicles you can eliminate entirely to reduce costs?

— Do you offer custom products?  Are your standard products customizable? Does any pricing differential adequately cover the costs involved in the customization?

— How much pre-sales support is required by each customer/customer segment?  Are there ways to reduce the amount of pre-sales time and effort involved for some or all of your customers/segments? 

— Is there a minimum order quantity?   What economies are lost with small order quantities? Can that be addressed through pricing or fees?  

— How are your orders processed – manually or electronically? If they are entered manually, can you migrate to an electronic system to reduce errors? 

— What other processes that you handlemanually can you automate?  Are there any other very labor-intensive processes that you can make more efficient? 

— Do you offer multiple delivery options?  Are alternative/premium delivery options covered by a price differential? 

— How much post-sales support is required by each customer/customer segment? Are there less expensive ways to support customers? 

— How quickly do customers pay?  Are there ways to encourage faster payment?  Be persistent in your efforts to reduce costs and adjust the profitability equation for your customers. In almost any business, there is room for improvement, and you’ll see the effect directly on your bottom line.

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