business

Profitability method

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To remain competitive, companies must determine how to keep customers longer, grow them into bigger customers, make them more profitable, serve them more efficiently, and target acquiring more profitable customers. But there’s a problem with pursing these ideals. Customers increasingly view suppliers’ products and standard service lines as commodities. This means that suppliers must shift their actions toward differentiating their services, offers, discounts, and deals to different types of existing customers to retain and grow them. As companies shift from a product-centric focus to a customer-centric focus, a myth that almost all current customers are profitable needs to be replaced with the truth. Some high-demanding customers may indeed be unprofitable! Unfortunately, many companies’ managerial accounting systems aren’t able to report customer profitability information to support analysis for how to rationalize which types of customers to retain, grow, or win back and which types of new customers to acquire.

The marketing and sales functions already intuitively suspect that there are highly profitable and highly unprofitable customers, but management accountants have been slow to reform their measurement practices and systems to support marketing and sales by providing the evidence. Who are the troublesome customers, and how much do they drag down profit margins? What’s the difference between a valuable customer and a profitable one? More important, once these questions are answered, what corrective actions should managers and employees take to increase the profit from a customer?

After adding the nonproduct-related costs to serve for those customers, apart from the costs of the mix of products and standard service lines they purchase, these customers may be unprofitable to a supplier. Every supplier has what I call good and bad customers. For example, the latter constantly returns goods or contacts the supplier’s help desk. In contrast, the former just purchases a company’s products or service lines and are rarely bothersome to the supplier. These observations have been around for decades. Do we push for volume or for margin with a specific customer? Are there ways to improve profitability by altering the way we package, sell, deliver, or generally service a customer?