Customer-Profitability Profiles

Learning Objective 2 Identify the importance of customer-profitability profiles

• expand relationships with profitable customers, change behavior patterns of unprofitable customers, and highlight that a small percentage of customers contributes a large percentage of operating income

Customer-profitability profiles are a useful tool for managers. Exhibit 15-4 ranks the Provalue Division’s 10 wholesale customers based on customer-level operating income. (We analyzed four of these customers in Exhibit 15-3.)

Column 4, computed by adding the individual amounts in column 1, shows the cumulative customer-level operating income. For example, Customer C shows a cumulative income of $13,260,000 in column 4. This $13,260,000 is the sum of $5,690,000 for Customer B, $4,915,000 for Customer A, and $2,655,000 for Customer C.

Column 5 shows what percentage the $13,260,000 cumulative total for customers B, A, and C is of the total customer-level operating income of $15,027,500 earned in the wholesale distribution channel from all 10 customers. The three most profitable customers contribute 88% of total customer-level operating income. These customers deserve the highest service and priority. It is common for a small number of customers to contribute a high percentage of operating income. Microsoft uses the phrase “not all revenue dollars are endowed equally in profitability” to stress this point. Companies keep their best customers happy in a number of ways, including special phone numbers and upgrade privileges for elite-level frequent flyers and free usage of luxury hotel suites and big credit limits for high rollers at casinos. Concepts in Action: Amazon Prime and Customer Profitability describes how Amazon introduced Amazon Prime to support its most profitable customers.

Column 3 shows the profitability per dollar of revenue by customer. This measure of customer profitability indicates that, although Customer A contributes the second-highest operating income, the profitability per dollar of revenue is lowest among the top six customers because of high price discounts and higher customer-level costs (see sections Customer-Revenue Analysis and Customer-Level Costs). To increase operating income margins for Customer A, managers would need to decrease price discounts or save customer-level costs while maintaining or increasing sales. Customers D, F, and J have high operating income margins but low total sales. For these customers, managers would like to increase sales while maintaining margins. With Customers E, G, H, and I, managers have the dual challenge of boosting sales and operating income.

Presenting Profitability Analysis

Exhibit 15-5 illustrates two common ways of displaying the results of customer-profitability analysis. The bar chart presentation in Panel A (based on Exhibit 15-4, column 1) is an intuitive way to visualize customer profitability because (1) the highly profitable customers clearly stand out and (2) the number of “unprofitable” customers and the magnitude of their losses are apparent. Panel B of Exhibit 15-5 is a popular alternative way to express customer profitability. It plots the contents of Exhibit 15-4, column 5. This chart is called the whale curve because it is backward-bending at the point where customers start to become unprofitable (cumulative customer-level operating income goes from 111% after accounting for Customer E to 100% after accounting for Customer I) and thus resembles a humpback whale.^*

Exhibits 15-2 to 15-5 emphasize annual customer profitability. Managers should also consider other factors when prioritizing customers, including the following:

• LIKELIHOOD OF CUSTOMER RETENTION. The more likely a customer will continue to do business with a company, the more valuable the customer, for example, wholesalers who have sold Provalue each year over the last several years. Customers differ in their loyalty and their willingness to frequently “shop their business.”
• POTENTIAL FOR SALES GROWTH. The higher the likely future sales to a customer, the more valuable the customer. Customers to whom a company can cross-sell other products profitably are even more desirable, for example, wholesalers also willing to distribute Astel’s Deskpoint brands. If wholesalers sell both Provalue and Deskpoint, managers need to assess customer profitability based on sales of both Provalue and Deskpoint.
• LONG-RUN CUSTOMER PROFITABILITY. This factor is influenced by the first two factors—likelihood of customer retention and potential sales growth—and the cost of customer-support staff and special services required to support the customer.
• INCREASES IN OVERALL DEMAND FROM HAVING REFERENCE CUSTOMERS. Customers with established reputations, also called reference customers, help generate sales from other customers through product endorsements.
• ABILITY TO LEARN FROM CUSTOMERS. Customers who provide ideas about new products or ways to improve existing products are especially valuable, for example, wholesalers who give Astel feedback about key features such as size of memory or video displays.

Managers should be cautious about discontinuing customers. In Exhibit 15-4, the current unprofitability of Customer G, for example, may not be indicative of Customer G’s profitability in the long run, for example, because of higher anticipated sales. Moreover, as in any ABC-based system, the costs assigned to Customer G are not all variable. In the short run, it may be efficient for the Provalue Division managers to use spare capacity to serve Customer G on a contribution-margin basis. Discontinuing Customer G will not eliminate all costs assigned to Customer G and may result in losing more revenues relative to costs saved.

Of course, particular customers might be chronically unprofitable and hold limited future prospects. Or they might fall outside a company’s target market or require unsustainably high levels of service relative to the company’s strategies and capabilities. In such cases, organizations sever customer relationships. For example, Capital One 360, one of the largest direct lenders and fast-growing financial services organizations in the United States, asks 10,000 “high maintenance” customers (for example, those who maintain low balances and make frequent deposits and withdrawals) to close their accounts each month.^*