What is customer profitability
Profitability is every businesses goal. Many factor can influence how attainable and sustainable it is, and one of those factors is your customer profitability. Customer profitability is far more than just the gross or net margin generated on a transaction or even their calculated lifetime value. A proper customer profitability analysis involves every touch point that customer has with your company, including customer service contacts, returns, custom fulfillment costs and more.
Why measuring customer profitability is important
Measuring customer profitability is a crucially important and can be an enlightening exercise. Once you build the framework, it should be easier to refresh annually, or as often as makes sense for your business. The significant value that you gain through this exercise is determining if certain customers are actually costing you money rather than making you money. In some instances, you could find that the customer group you thought was the most important could actually be of lower value to the company than others, which would incite a shift in overall strategy.
If you’re wondering how some customers could be costing you money, it usually comes down to servicing costs. Do you have certain customers who call customer service frequently? Are there certain customers who have special requirements for fulfillment that cost more in labor and fulfillment costs? Or perhaps you offer customers free shipping and free returns, are there customers who are using that service too much?
How to measure customer profitability
The first step to measuring customer profitability is truly understanding your business and all of the places that a customer might interact with any area of your company. Beyond the actual product or service cost for what they buy from you, other costs might be:
- Marketing costs
- Customer service contact costs
- Social media contact costs
- Shipping costs (especially if you fund return shipping)
- Return costs, including restocking or refurbishing
Once you have your list of all the ways customers can interact with your company, you’re ready to move onto Step 2.
Step 2: Define your customer groups
Some businesses have well-defined customer segments that could be based on size of business or business unit they buy from, or perhaps they are more behaviorally based from a segmentation exercise. If you don’t have these customer groups easily defined, you can define them now. Based on your business, what types of customers do you have and why do they buy from you? Even if you don’t have empirical evidence or a big 3rd party study to define these, you know your business and product(s) and can define these segments.
Step 3: Find the Data
Now onto Step 3 where you put on your detective hat, it’s time to search for the details and you’ll need help from colleagues in the business areas from Step 1. The first question is…do we have data? You probably have data, but is it tracked and accessible in an easy way?
It’s unlikely you’ll find every piece of data tied to every single customer, usually things like customer service costs are lumped together as one expense as a line item in SG&A. But you can start putting more science to it. For example, do you track customer service interactions to the customer? It’s possible you could take a sample of customer service inquiries and determine the customer groups that might over-index in contacting you. The next question is why? The reasons for these costs, be it customer service contacts, returns or others will come in handy later.
Marketing spend and cost per transaction is another important one, there could be hidden pearls in this data when you break it down by marketing channel and tie it to specific customer groups.
Ultimately what you’ll end up with, at a minimum, is an average cost per activity, such as:
- Marketing cost to generate an order
- Average customer service contact per order
- Average cost per customer service contact
- Average return rate
- Average shipping cost
Step 4: Putting it together. A customer profitability analysis example.
Let’s say you have 2 customer segments, Segment A and Segment B. A high-level glance at the revenue they drive for your business on each transaction makes Segment B look much more attractive:
Armed with this data alone, you may shift your strategy, budgets, even product development pipeline to cater more to Segment B. Afterall, they are 25% more valuable than Segment A. Based on these numbers, that would be a solid plan.
But, what if Segment B customers aren’t actually great customers?
Let’s say they have special fulfillment requests that ends up costing 25% more in labor and fulfillment fees. And after all of that, they actually return or cancel orders at a significantly higher rate than Segment A customers. Now they’re not looking like they are quite as good as they did at the start of this example. All of those hidden costs might look something like this:
Yikes, those picky Segment B customers are actually costing you a lot of money, not including the cost of the actual product/service. Putting it all together, you would be better off shifting your focus, strategy and budgets towards Segment A customers for the long term health and growth of your business:
How to improve customer profitability
Striving to improve customer profitability is an on-going effort. The first and probably easiest action to take is to maximize your most profitable customer group. What proportion are they of your total business? Could they be bigger and how? Evaluate the necessary resources, budget and requirements to grow this customer segment.
That doesn’t mean you should abandon all other customer segments. Just because Segment B in the example above costs more money than Segment A, doesn’t mean you should never sell to Segment B again. There are likely areas that could improve these metrics. This comes back to the WHY mentioned earlier. What did you learn in your investigations to these areas that could point to a root cause? Can you add details to the sales process that help guide customers to a product/service that better meets their expectations? Are there policies that could be implemented to prevent some of these costs? Perhaps it’s time to implement automation or SaaS tools to ease the process of buying and selling.
Customer profitability is far more than just the revenue that a customer brings in. Taking the time to evaluate each area of a customer’s journey with your company can reveal insights that have meaningful impact on your business strategy and your bottom line. Once you determine the data you will use and build out a structure, it should be easy to refresh this data in an ongoing fashion as your business grows.