Chapter 25
Customer Profitability

Customer profitabilityi measures whether the resources used (time, financial, effort) yield positive results.

Customer profitability models measure total revenues and total costs for customers during the period of time being measured, helping drive resource allocation decisions for individual customers. Calculating revenues minus costs attributable to each customer is sufficient for determining profitability:

Where

rt = revenues from the customer during time t

ct = costs incurred to acquire and support the customer during time t

To illustrate, assume a consumer products company is interested in knowing customer profitability, but not at the individual consumer level, even though the final end user is the mass consumer. Acquiring such detailed knowledge would not be cost effective since the company is structured to deliver large volumes of product to a wide range of intermediaries and locations. Instead, investment is made in marketing programs designed to strengthen relationships with wholesalers and retailers. Wholesaler marketing programs include volume pricing, preferred terms, and rapid inventory replenishment. Retailers marketing programs include slotting allowances, which are fees paid to retailers to ensure product placement on store shelves, and co-op advertising, which is an agreement between manufacturers and retailers to share product advertising and/or promotion costs. Customer profitability in this situation is an aggregated figure, based on the revenues resulting from sales to wholesalers and the costs associated with those transactions, including any fees paid to retailers.

The measurement of customer profitability is an exercise in simple calculation. Of course, one-time customers can skew this approach, since it is likely that the costs to acquire the customer are higher (versus established customers familiar with the company and its products) relative to the return (measured via increased revenues, profits, or both). Therefore, it may be more useful to review loyal customers whose cost to service and purchase patterns are better known. However, astute marketers know that customers have different values. Don Peppers and Martha Rogers, of Peppers & Rogers Group, are among the leading experts in customer profitability.ii They assert that not all customers are equal, let alone equally profitable, and their one-to-one model describes approaches for enhancing the value of every customer relationship. Most businesses experience the 80/20 rule (80% of the money comes from 20% of the customers), or a close approximation of this. Determining specific profitability per customer is challenging since costs are hard to accurately assign or allocate. Managers must take the time to understand the profile of customers contributing the most profits and develop programs that continue to develop these important relationships.

To find the revenue and cost figures, marketers can begin their research as follows:

1. Revenue figures: The finance and accounting departments in most companies will have sales data and transaction records for each product for the specific period of time being reviewed, derived from actual payments received from each customer. This information is summarized in the income statement.
2. Cost figures: Determining costs accurately can be challenging due to different materials costs, labor differences, royalties paid to each supplier, support costs, and different marketing programs for each customer. The accounting department will typically aggregate all costs associated with a specific product, allocating it evenly across various customers, even though each customer may have unique purchase patterns.

iE. Ofek, “Customer Profitability and Lifetime Value,” Harvard Business School Article, 9-503-019, August 7, 2002; SAS, Five Tips for Improving Customer Profitability from Harvard Business Review. Retrieved June 3, 2017 from https://www.sas.com/hu_hu/insights/articles/marketing/Five-ways-to-improve-customer-profitability-from-Harvard-Business-Review.html

iiD. Peppers and M. Rogers, “The State of Customer Experience in Retail Banking Don’t Get Left Behind,” (vol. 2, 2011), 9. Retrieved May 30, 2017 from http://www.peppersandrogersgroup.com/pdf/white-papers/wp-finserv-customer-experience-retail.pdf, “Measure the Value of Customer Experience Improvements. Customer Experience Value Analysis Connects Customer Initiatives to Tangible Financial Impact” (2014), 4–6. Retrieved May 30, 2017 from http://www.peppersandrogersgroup.com/pdf/white-papers/wp-tech-measure-the-value.pdf; Magnus Söderlund and Mats Vilgon, “Customer Satisfaction and Links to Customer Profitability: An Empirical Examination of the Association Between Attitudes and Behavior.” SSE/EFI Working Paper Series in Business Administration No. 1999: 1 (January 1999), 2–3. Retrieved May 8, 2017 from http://swoba.hhs.se/hastba/papers/hastba1999_001.pdf