Not all customers are the same. Some customers are profitable and others less profitable depending on the behaviour they exhibit. Some people believe that the customer is always right and should therefore be satisfied at all cost. I tend to differ on this notion. Although customer satisfaction is crucial, the organization’s long-term goal is to increase customer and corporate profitability.
Achieving this goal requires management to strike a balance between managing the level of customer service to earn customer satisfaction and the impact this will have on shareholder wealth. The best solution is to increase customer satisfaction profitably.
Some customers, suppliers and trading partners are extremely high-maintenance. Unlike customers who place standard orders with no fuss, high-maintenance customers demand nonstandard everything. They are always asking for that special treatment. For example, they make unwarranted delivery changes and require more after-sale services. If that is not enough, you always hear from them and in most cases to inquire about and speed up their order, or return or exchange their goods. If you add up all these costs-to-serve plus the costs of the products and base service lines you will be surprised to discover the magnitude of the erosion happening to your bottom line.
Knowing who your troublesome suppliers and customers are and also how much they are eroding the organization’s profit margins is critical for effective resource allocation and decision making. What kinds of customers are loyal and profitable? Of your existing customer profile, which customers are only marginally profitable or, worse yet, losing you money? Does the customer’s sales volume justify the discounts provided to that customer? Using Activity Based Costing/Management (ABC/M) techniques helps managers and employees find solutions to these questions and take corrective actions. Through ABC/M analysis, managers and employees will be able to trace, group and reassign costs based on the cause-and-effect demands generated by customers and their orders.
With better cost data at its disposal, the organization will be able to decide whether to push for volume or for margin with a specific customer, to alter its product and service offering to improve profitability or to assess whether benefits can be realized from changing current strategies by influencing its customers to alter their behaviour and buy differently and more profitably. This in turn enables the organization to become more competitive because it knows its sources of profit as well as understand its cost structure.
The whole idea of carrying out the organization’s customer and channel profitability analysis is to identify the less-profitable customers and suppliers. Having identified these troublesome suppliers and customers, then what? Should you immediately terminate your relationship with these customers? Should you continue business as usual? What about the already profitable customers? Must you streamline your delivery processes to reduce the costs-to-serve? With the facts, unprofitable customers can be migrated to higher profitability through managing service costs, introducing new products and service lines, offering discounts to gain more volume with low cost-to-serve customer, reducing their services, renegotiating prices or shifting their purchase mix to richer and higher-margin products.
Remember customers with high sales volume are not necessarily highly profitable. Customers tend to cluster. Medium-volume customers can be much more profitable than large-volume customers. Each customer’s profitability level depends on whether the net revenues are sufficient to recover the customer-specific costs-to-serve. It is therefore important to know the types of customers that cluster in the various profit or loss zones as this can be valuable in determining what actions to take.
Furnished with better cost data, the organization can protect its most profitable customers from competitors. Because so few customers account for a larger portion of the organization’s profit, management must focus on retaining these profitable customers and derive value from their loyalty. For those customers who drain resources and time, yet provide negative financial return and are concluded impractical to achieve profitability with them, they should be terminated.