Customer-Profitability Analysis

Learning Objective 1 Discuss why a company’s revenues and costs differ across customers

revenues differ because of differences in quantities purchased and price discounts, while costs differ because of different demands placed by customers on a company’s resources

Customer-profitability analysis is the reporting and assessment of revenues earned from customers and the costs incurred to earn those revenues. An analysis of customer differences in revenues and costs reveals why differences exist in the operating income earned from different customers. Managers use this information to ensure that customers making large contributions to the operating income of a company receive a high level of attention from the company and that loss-making customers do not use more resources than the revenues they provide. As described at the start of this chapter, at Starbucks, managers use customer-profitability analysis to reward profitable customers who spend more with many perks.

Consider again Astel Computers from Chapter 14. Recall that Astel has two divisions: the Deskpoint Division manufactures and sells high-end computers, and the Provalue Division manufactures and sells Intel Core i9 chip-based laptop computers. Exhibit 15-1, which is the same as Exhibit 14-3, presents data for the Provalue Division of Astel Computers for the year ended 2019. Astel sells and distributes Provalue through two channels: (1) wholesalers who sell Provalue to retail outlets and (2) direct sales to business customers. Astel sells the same Provalue computer to wholesalers and to business customers, so the full manufacturing cost of Provalue of $680 is the same regardless of where it is sold. Provalue’s listed selling price in 2019 was $1,100, but price discounts reduced the average selling price to $1,000. We focus on customer profitability for the Provalue Division’s 10 wholesale distributors.

Spreadsheet screenshot shows the profitability of Provalue Division for 2019, using value-chain activity based costing.

Details of the total amount for 150,000 units and per unit costs are as follows:

(A) Total amounts for 150,000 units

1. Revenues: $150,000,000

2. Costs of goods sold (from Exhibit 14-2): 102,000,000

3. Operating costs

• R &D costs: 2,400,000

• Design costs of product and process: 3,000,000

• Marketing and administration costs: 15,000,000

• Distribution costs: 9,000,000

• Customer-service costs: 3,600,000

• Operating costs: 33,000,000

4. Full cost of the product: 135,000,000

5. Operating income: $15,000,000

(B) Per unit cost (calculated by dividing the total amounts by 150,000)

1. Revenues: $1,000

2. Costs of goods sold (from Exhibit 14-2): 680

3. Operating costs

• R &D costs: 16

• Design costs of product and process: 20

• Marketing and administration costs: 100

• Distribution costs: 60

• Customer-service costs: 24

• Operating costs: 220

4. Full cost of the product: 900

5. Operating income: $100

(C) Note

• Cost of goods sold equals Total manufacturing costs because there is no beginning or ending inventory of Provalue in 2019.

• Numbers for operating cost line-items are provided without supporting calculations.

Customer-Revenue Analysis

Consider revenues from four of Provalue’s 10 wholesale customers in 2019:

Table shows revenues from Provalue’s four wholesale customers A, B, G, and J.

Details of the units sold, list selling price, price discount, invoice price, and revenues are as follows:

Customer A
- Units of Provalue sold: 30,000
- List selling price: $1,100
- Price discount: $100
- Invoice price: $1,000
- Revenues (Product of units sold and invoice price): $30,000,000
Customer B
- Units of Provalue sold: 25,000
- List selling price: $ 1,100
- Price discount: $ 50
- Invoice price: $1,050
- Revenues (Product of units sold and invoice price): $26,250,000
Customer G
- Units of Provalue sold: 5,000
- List selling price: $ 1,100
- Price discount: $ 150
- Invoice price: $ 950
- Revenues (Product of units sold and invoice price): $4,750,000
Customer J
- Units of Provalue sold: 4,000
- List selling price: $1,100
- Price discount: n/a
- Invoice price: $1,100
- Revenues (Product of units sold and invoice price): $4,400,000

Two variables explain revenue differences across these four wholesale customers: (1) the number of computers they purchased and (2) the magnitude of price discounting. A price discount is the reduction in selling price below list selling price to encourage customers to purchase more quantities. Companies that record only the final invoice price in their information system cannot readily track the magnitude of their price discounting.^*

Price discounts are a function of multiple factors, including the volume of product purchased (higher-volume customers receive higher discounts) and the desire to sell to a customer who might help promote sales to other customers. In some cases, discounts result from poor negotiating by a salesperson or the unwanted effect of a company’s incentive plan based only on revenues. At no time, however, should price discounts stem from illegal activities such as price discrimination, predatory pricing, or collusive pricing (see Chapter 14, Managing Environmental and Sustainability Costs).

Tracking price discounts by customer and by salesperson helps improve customer profitability. For example, the Provalue Division managers could decide to strictly enforce its volume-based price discounting policy. The company could also require its salespeople to give only a limited number of discounts to customers who do not normally qualify for them. In addition, the company could track future sales to customers, such as Customer G, who have received sizable price discounts on the basis of their “high growth potential.”

Customer revenues are one element of customer profitability. The other, equally important element is the cost of acquiring, serving, and retaining customers.