Managing Customer Profitability

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6

• Managing Customer Profitability

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Customer Profitability Analysis
Analyzing the activities, costs, and profit
associated with serving specific customers.
For various reasons, some customers are less
profitable than others.
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Customer Profitability Analysis
Two primary objectives
Identify Effective and Ineffective Customer-Relat
ed Activities
Measure Customer Profitibility
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Measuring Customer Profitability
Studies have shown that only 20 of a companys
customers contribute to profits. The remaining
80 generate losses.

• Possible qualitative reasons toretain
  unprofitable customers
• Customer prestige.
• Potential future profitability.
• Loss leader to enter market.
• Nonmonetary benefits such as knowledge or
  expertise.

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Measuring Customer Profitability
A graph of five of our customers revealsthat two
of the five are unprofitable.
Bar graphsare common analytical tools.
Customer Profitability
Customer Number
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Measuring Customer Profitability
We will focus our attentionon customers 102 and
114.
Question Why are these two customers
unprofitable?
Customer Profitability
Customer Number
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Measuring Customer Profitability
Comparing the customer-related costs foreach
customer can reveal helpful insights.
We Investigate and find. . .
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Customer Profitability Analysis
Once we know why the customers are unprofitable,
we can modify customer relationships to improve
profitability.
Well send a team to your plant next week and
help you set up ordering and handling procedures
that will reduce costs and provide you with
better service.
I hate to do this, but we just cant continue
doing business with you.
If you ask for fewer changes, we can charge you
less and deliver your orders faster!
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Identify Effective Ineffective Customer-Related
Activities
Study closely all the customer-relatedactivities
that drive costs.
Typical Customer-Related Activities Include

• Processing Orders
• Sales Contacts
• Sales Visits
• Processing Shipments

• Billing
• Engineering/Design Changes
• Special Packaging
• Special Handling

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Customer Profitability Analysis
HealthWave, Inc.
(Textbook Example)

• HealthWave, Inc. sells non-prescription
  pharmaceuticals, supplements, and herbal remedies
  to three major customer types
• Pharmacy
• Grocery
• Herbal Therapist

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Customer Profitability Analysis
Exh. 6.2
Healthwave reports product line
profitability. Research and Development (R D)
costs are tracedto products, but General,
Selling and Administrative(G,S and A) costs are
allocated based on sales.
The profitability goal is a 10 percent return on
sales. Is the problem products or customers?
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Customer Profitability Analysis
We now know that the supplements linehas a low
return on sales and that herbalremedies has a
negative return on sales. An analysis of sales
records shows the followingcustomer sales
patterns for these products
Now lets look at contribution margin per
customer type.
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Customer Profitability Analysis
Exh. 6.5
78 of 26,900,000 8 of 44,260,000 5 of
19,840,000 25,514,800
(78 of 26,900,000) .52 (8 of 44,260,000)
.61 (5 of 19,840,000) .69 13,755,008
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Customer Profitability Analysis
Exh. 6.5
Sales to Pharmacies provide the highest
contribution margin ratio. Lets examine further.
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Sales Administrative Cost Analysis
We will analyze these costs to determine how much
of eachcost to subtract from customer margin.
Our objective iscustomer income and return of
sales for each customer.
Selling Costs
R D Costs
Marketing Costs
Distribution Costs
General Administrative Costs
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Selling Cost Analysis
Exh. 6.6
HealthWave sells its products using sales
personnelin the field and by telephone ordering.

45 sales reps _at_ 55,000
25 sales reps _at_ 42,000 4 majoraccount
managers _at_ 200,000
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Selling Cost Analysis
Exh. 6.6
HealthWave sells its products using sales
personnelin the field and by telephone ordering.

• 40,000 grocery orders 85 by telephone
  34,000 grocery telephone orders
• 34,000 80,000 total telephone orders 42.5
  percent of telephone orders
• 42.5 percent of 130,000 total telephone cost
  55,250

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Selling Cost Analysis
Exh. 6.6
HealthWave sells its products using sales
personnelin the field and by telephone ordering.

Percentage based onpersonnel interviews
62 of 480,000 297,600
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Marketing Cost Analysis
Exh. 6.7
Marketing costs include personnel, databases,
equipment, and facilities used for selling,
market research, strategy, and planning.
Percentage based onpersonnel interviews
55 of 360,000
56 of 2,250,000
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Distribution Cost Analysis
Exh. 6.8
Distribution costs include packing, shipping and
delivering products or services to customers.
HealthWave delivers goods using its own trucks
and a private delivery service, PackageXpress.
12 of 16,085,800 Herbal Therapist Revenue
(rounded)
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Distribution Cost Analysis
Exh. 6.8
Pharmacy deliveries 286,000 87.66 Grocery
deliveries 40,248 12.34 Total
deliveries 326,248 100.00
12.34 of 8,080,000
87.66 of 8,080,000
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Research and Development cost Analysis
Exh. 6.9
R D costs are charged to product lines in the
year of spending. For the current year, 40
percent of R D costs are charged to supplements
and 60 percent to herbal remedies.
Product Non-prescription 0
0 Supplements 40 480,000 Herbal
remedies 60 720,000 Total R D
costs 100 1,200,000
Next, the amounts charged to product lines
areallocated to customer types based on sales
revenue.
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Research and Development cost Analysis
Exh. 6.9
78 of 0 8 of 480,000 5 of 720,000
22 of 0 83 of 480,000 34 of 720,000
0 of 0 9 of 480,000 61 of 720,000
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General Administrative Cost Analysis
Exh. 6.10
These costs can often be difficult to trace to
specific customers. HealthWave breaks them into
these categories manufacturing support (30),
customer service (50), and general business
activities (20). Percentages were obtained from
management interviews.
(20 50 ) or 70 of 8,270,000
30 of 8,270,000
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General Administrative Cost Analysis
Exh. 6.10
Allocate customerservice basedon revenues.
28.04 of 5,789,000
17.68 of 5,789,000
54.29 of 5,789,000
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General Administrative Cost Analysis
Exh. 6.10
Allocatemanufacturingservice based onvariable
COGS.
25.16 of 2,481,000
19.72 of 2,481,000
55.13 of 2,481,000
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Customer Profitability Analysis
Exh. 6.11
Finally, we put all the information together to
determinewhich customer-type is the most
profitable.
Even though Pharmacy has the highest margin, it
has a negative return on sales. What should
Healthwave do?
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What To Do?
HealthWave, Inc.
The Pharmacy customers are not contributing to
HealthWaves profitability. What are the options?
Decrease operating costs
Do Nothing
Increase efficiency of serving pharmacy customers
Drop pharmacy customers
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What To Do?
HealthWave, Inc.

• Do nothing is unacceptable given the magnitude
  of the loss.
• Dropping the pharmacy customers should only be
  considered if the cost savings are greater than
  the 11,759,792 of contribution that would be
  given up.
• Decreasing operating costs and/or increasing
  the efficiency of serving pharmacy customer
  appear to be the best options.

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Common-Sized Profit Statements
To better compare different sets of data, the
dollar amounts can be recast as a percentage of
revenues.
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Common-Sized Profit Statements
Pharmacy margin is high, butsome costs seem out
of line.
Potential Savings?
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End of Chapter 6