Customer Profitability – The measure that really matters!

Customer related costs can easily chew up product or service profitability. I hope you agree; but let me explain to ensure a quality discussion.

Typically, product or service costs contain direct costs and some “allocated” indirect costs. (I say “allocated” because it is a word I DESPISE, since it typically means non-causal, general, and nearly arbitrary spreading of costs.) Revenue – Product/Service Cost = Gross Margin, emphasis on “gross”, meaning: There is much you do not know!

Customer Cost brings in many costs associated with customer specific resources and processes not included in traditional product/service cost. Ideally, these should include: sales force time; product or service design or modification costs; ordering costs – frequency, size, modifications, cancellations, returns, and order complexity; collection/financing costs and performance; picking, packaging, and delivery costs; warranty and after sales support costs; and perhaps many industry unique customer requirements. Of course, some of these activities may generate some revenue in addition to the product or service, so it is important to look at Customer Profitability, not just Customer Cost. Furthermore, it is often a good idea to look beyond the immediate period and consider the longer term or lifetime value of a customer.

How many organizations have continuous, comprehensive Customer Profitability systems and reviews in place? Sadly, not nearly as many as should. Why do they choose to go without this information? Or look at it only occasionally as a special project? Primarily, it is because they don’t have the data or a system to generate the data and calculate the information readily. A sad commentary on the capability of finance and accounting in the age of increasing data analytics and technological capability.

But it’s not really the analytical or technology capability, is it? It’s really about the ability of finance and accounting to think outside and beyond the financial accounting and financial reporting model it is so invested and well-trained in. There is OPPORTUNITY here for organizations that think and invest to get ahead of the pack!

For more insight, PACE and Doug Hicks will be soon putting out a podcast on his 3 Laws of Pricing which speaks very practically to the impact of bad cost and profitability information. (Doug also has an existing PACE Forum post on his 3 Laws of Pricing.) PACE director, Gary Cokins, has also written extensively on Customer Profitability, including an IMA Statement on Management Accounting.