Customer Profitability

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21 Aug, 2024

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Customer Profitability refers to the profit a business generates from servicing a customer or group of customers over a predetermined amount of time. It is the difference between the income received from and the expenses related to the client relationship over a given length of time.

It makes it easier to identify how each customer, or group of customers, contributes to overall profitability. Additionally, these profiles make it easier to identify the least profitable or those for whom the overhead costs outweigh the profit margin. Then, the interests of the top clients can be given priority when creating new or providing current ones.

What Is Customer Profitability?

Customer profitability meaning refers to it as the profit business organizations make by servicing a customer or customer group over a specific period. It helps identify the contribution of each customer to overall profitability and prioritizes high-profit customers.
Accurate revenue and expense allocation is crucial in measuring customer profitability. Tools like a customer profitability matrix and reports can aid in measuring and assessing it.
CPM focuses on strategies to increase the value of high-profit customers and mitigate profit erosion from low-profit customers.
Benefits of CPA include identifying high-profit customers, optimizing marketing efforts, enhancing customer satisfaction, effective resource allocation, improving pricing strategies, and making data-driven decisions.

Customer Profitability Explained

Customer profitability is the profit a business generates from servicing a customer or group of customers over a predetermined period. It focuses on the discrepancy between profits and expenses related to the client relationship. It aids firms in understanding productivity and resource allocation by figuring out each customer's profitability. Better resource allocation and decision-making are made possible by all of these facts.

Businesses must use it as a critical tool to discover and rank high-value clients. By offering insights into consumer behavior, preferences, and profitability factors, it enhances customer centricity and makes data-driven decisions possible. Businesses can maximize profitability by comprehending their demands, optimizing pricing methods, and allocating resources effectively through analysis.

Regardless of whether net profit or net cost is employed, determining the contribution of individual customers or customer groups to a business's financial success is the process of measuring customer profitability. It is required as only some clients make a direct financial contribution to a business. By forecasting revenues and expenditures associated with customer discontent in the upcoming years of cooperation, businesses can determine how much of contribution a consumer has made to their current profit or assess customers' potential to generate future profits.

How To Measure?

It is essential to confirm the company's method of calculating revenue and expense to measure profitability per customer, which is

Profit = Revenue – Expenses

Some companies use cash-based accounting, but accrual-based accounting is recommended for larger businesses. Businesses need to allocate as many expenses through the customer as possible, considering capital, debt, and operational costs. Once it has the revenue and expenses for a specific customer, calculate its profitability. The next step would be to analyze all of the customers to ensure they are profitable.

Customer Profitability Analysis (CPA) and Customer Lifetime Value (CLV) are two standard methods used to measure a customer's value to an organization. CPA is a retrospective analysis of a customer's business results over a single period, while CLV is a predictive measure of customer-related net cash flows over multiple future periods. The choice between these approaches depends on the organization's situation and the complexity of the analysis.

Examples

Let us understand the concept with the help of some hypothetical and real world examples.

Example #1

Consider Daisy, a digital marketing professional, gauging her customer profitability to determine the profit generated from servicing each customer. By identifying her most profitable customers, she strategically directs marketing efforts and allocates resources to optimize customer satisfaction and increase revenue. Focusing on high-profit clients enhances customer happiness and contributes to the overall growth and profitability of Daisy's firm.

Example #2

Moneythor's platform addresses the pressing challenges faced by global banks in customer acquisition and engagement. According to a survey conducted with FinTech Futures, less than a quarter of respondents found their acquisition methods compelling. Financial institutions reported a 15% drop-off rate among newly acquired customers within three months, with a prolonged 12-month timeline for a customer to become profitable. In response, Moneythor has introduced the concept of Customer Activation Management, offering a systematic process covering acquisition, engagement, and motivation.

The platform boasts features like advanced referral management, points, vouchers, gift cards, cashback, challenges, and gamification techniques, aiming to enhance the adoption and utilization of financial services. Olivier Berthier, Moneythor's CEO, believes their platform and Customer Activation Management offer a definitive solution to the challenges faced by banks in ensuring long-term customer profitability.

The platform is adaptable, integrating seamlessly with any core banking system, providing flexibility for both banks and fintech firms. Berthier emphasizes that legacy techniques have left these institutions underserved, leading to missed opportunities, and advocates for a more comprehensive and practical approach to meet the evolving needs of the financial industry.

How To Manage?

The strategy-linked method of determining the relative profitability of various customers or customer profitability segments is known as customer profitability management or CPM. It seeks to create strategies that increase the value of the most lucrative customers. They can stop or lessen the profit erosion caused by the least profitable customers or concentrate on the long-term profitability of the consumers.

The core component of the CPM system is a costing system that, in the absence of arbitrary broadly averaged cost allocations, traces and causally allocates costs to each customer or a specific segment. Choosing and putting into place a precise and instructive costing system is the main obstacle to establishing a CPM system. It should correctly allocate gross margin and product costs to individual customers or customer groups.

Benefits

Some of the benefits of this are given as follows:

Identifying high-profit customers and segments: Businesses can identify their most valuable customers and customer segments. It enables them to concentrate their resources and efforts on the customers who yield the highest profits. This focus allows for targeted marketing, personalized services, and improved customer experiences. It drives business growth and long-term profitability.
Optimizing marketing and sales efforts for maximum profitability: It provides valuable insights into customer behavior, preferences, and drivers of profitability. Businesses can optimize their existing marketing and sales strategies with this information to cater specifically to the needs and preferences of high-profit customers. It leads to more effective campaigns, higher conversion rates, and increased revenue.
Enhancing customer satisfaction and loyalty: A deep understanding of customers empowers businesses to address the unique requirements of their most profitable customers. Tools such as a customer profitability matrix can be used for this. It can be done by delivering personalized experiences, tailored products or services, and exceptional customer service; businesses can elevate customer satisfaction and foster loyalty. Satisfied customers are likely to continue to support brands and recommend the business to others, thereby driving sustained profitability.
Allocating resources effectively and reducing costs: Customer profitability reports and analysis assist businesses in efficiently allocating their resources. By identifying low-profit or unprofitable customers, businesses can curtail investments in serving these segments and reallocate resources to high-profit customers. This optimization of resources leads to cost reductions, improved operational efficiency, and overall higher profitability.
Improving pricing strategies and revenue generation: A customer profitability report provides insights into pricing dynamics across different customer segments. Businesses can identify price-sensitive customers and high-margin opportunities. This knowledge enables them to develop pricing strategies that maximize revenue and profitability. For instance, they can offer premium products or services to high-profit customers or implement dynamic pricing based on customer value.
Making data-driven decisions based on customer profitability insights: CPA furnishes businesses with quantifiable data on customer value and profitability. This data empowers businesses to make informed, data-driven decisions in critical areas such as marketing, sales, product development, and resource allocation. Businesses can minimize guesswork and maximize their chances of success by relying on objective profitability metrics.

In summary, information about the profitability of customers helps with decision-making regarding selling prices, discounts, and service offerings. Additionally, it strengthens a business's negotiating position with clients by empowering management to stand behind rates and services that add value for clients without jeopardizing profits.

Frequently Asked Questions (FAQs)

1. What are the disadvantages of customer profitability?

One disadvantage of customer profitability is the potential complexity and resource intensity in implementing accurate cost allocation, making it challenging for some businesses. Additionally, focusing solely on short-term profitability may need to pay more attention to the long-term value of specific customers. Lastly, customer profitability metrics might only capture part of the spectrum of intangible benefits or brand loyalty that customers contribute to a business.

2. How to improve customer profitability?

Enhancing customer profitability involves strategies such as increasing revenue from high-profit customers through cross-selling, upselling, and personalized marketing. Additionally, businesses can reduce costs by streamlining operations, improving customer retention rates, and optimizing pricing strategies through enhanced experiences and loyalty programs.

3. What is the difference between customer profitability and customer lifetime value?

Customer profitability measures the immediate profit generated from serving a customer over a specific period, focusing on short-term gains. On the other hand, customer lifetime value (CLV) estimates the total value a customer is expected to bring to the business throughout their entire relationship, emphasizing long-term revenue potential and customer loyalty. While customer profitability assesses current contributions, CLV looks at the holistic, enduring value of a customer to the company.