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What is customer profitability analysis?

 Examines how customers, groups and individuals, differ in their

 Need to measure customer profitability so can give the ‘right’ amount of
attention to customers.
It’s easy to give lots of service but this is at a cost to the business

We can give customers different levels of service, only after understanding their
profits etc.

What questions should we ask in CPA?

 Which customers generate the largest profits?
How can we retain them?
How do we protect them from the competition?
 Which customers generate the smallest profit/or a loss?
Can we improve them to make them more profitable?
 Should we ‘discourage’ any customers (or even fire customers?)?
 How much should we spend on acquiring and retaining customers?

What is conventional customer profitability analysis?

Selling, general and administration (S, G&A) costs are often absorbed to
customers on the basis of:
Sales revenue, or
Direct cost of product or service, or
Gross profit of product or service
Assumes that SG&A costs for all customers (or customer groups) are incurred in
direct proportion to either sales revenue, product/service direct costs or gross

Do these really determine the SGA costs to all customers?

In a complex organisation that is trying to give high levels of service, perhaps

Advantages of CPA
 Conceptually simple
 Ideal for firms with:
o high product cost/low cost to serve
o only “off the shelf”/standard products
o anonymous customers
o fixed price lists
o no customisation
o Only a standard package with no after-sales service

Every customer is causing the same costs by taking a standard package

However, most firms are not offering homogeneous product as above. Therefore,
need to measure the differences in cost.
Weakness of conventional CPA
These conditions rarely apply!Costs are just being spread rather than accurately
 If have high cost to serve, use of a volume related absorption bases is
likely to be inaccurate.
 Absorbing SG&A costs on the basis of sales revenue or direct
product/service cost or gross profit is simply “allocation”…
Must ask:
Is there any customisation?
Do different customers, or customer groups, have different patterns of
costs to serve?

Customer Expense Categories

See the paper by Smith, Malcolm and Dikolli (1995).
Purchasing Pattern
e.g. size and frequency of orders will help determine how much time and
cost spent to deal with order
Delivery Policy
e.g. number, frequency and location
Accounting Procedures
e.g. discounts, many credits, pay late
Inventory Holding
e.g. Hold stock for JIT order/delivery – cheaper to deliver to customers that
notify you ahead of time when they want goods delivered.

The cost of serving customers depends on the level of CRM, customisation

How does CPA affect the ABC activity hierarchy?

Customers could influence costs at different levels of the ABC hierarchy

Customer related OH could affect the manufacturing or service delivery costs

Understanding the impact of selling to Wholesalers, retailers and

See the textbook
Also consider B2B and B2C
B2B – more likely they will dictate how you manufacture the products