Analysis of Customer Profitability Analysis (CPA)
In the current era, the industrial sectors are shifting from being product-oriented to customer-oriented. Customer relationship management is designed to gain an insight of customer behaviour, leverage and profitability for managing customers effectively in one-to-one relationship. The objective of customer relationship management is to draw new customers, retain, up-sell and cross-sell to the current customers. Customer profitability analysis (CPA) is a new practice in management accounting, which has developed in the growingly competitive business environment (Bonacchi, Kolev & Lev, 2015). In this environment, the conventional cost and margin analysis is not adequate and hence, they fail to provide complete overview for cost-profitability relationship. CPA enables the business organisations in disaggregating revenues and costs to individual product and customer levels for disclosing past hidden costs. Therefore, this paper would aim to evaluate the importance of customer profitability analysis in the contemporary business environment.
CPA is based on two foundations, which include activity-based costing (ABC) system and the associated activity-based management (ABM). As cited by Brierley (2016), ABC is a system of costing analysis for identifying the activities of an organisation and cost drivers followed by allocating costs to the activities. Both ABC and ABM are used as strategic techniques for the management in order to accomplish certain goals. Effective understanding of customer profitability by uncovering disclosing financial information resulting in detection and minimisation of non-value-added activities and rationalising procedures would assist in the following:
Firstly, cost-effective information is necessary for relating costs to customer and analysing customer return on investment. Valuable information is provided to guide the management in terms of marketing and costing strategies (Cambra-Fierro, Melero & Sese, 2015). Well-informed decision-making could be conducted compared to conventional gross margin analysis. The future customers could be selected along with targeting highly profitable industrial channels as well as customer types
CPA could be carried out by three approaches of ABC application, which include customer lifetime value, customer/channel profitability analysis and customers’ return on investment. These are evaluated briefly as follows:
CLV is a fact-based and comprehensive measure related to customer worth over life span of business association with the customers (Faria, Ferreira & Trigueiros, 2018). This concept is applicable to service as well as manufacturing organisations. Based on these values, CLV segregates customers into four groups, which constitute of demanders, champions, losers and acquaintances. Moreover, it measures four costs, which include acquisition, provision, service and maintenance. For better functioning of CLV, technology plays a crucial role. The use of sophisticated information collection techniques enables the data collection from the touch point of multiple customers. As a result, single application of customer relationship management could be evolved into integrated customer relationship management (Fish et al., 2017).
This is a strategic management accounting technique, which utilises ABC for analysing the profitability picture of an organisation at customer channel as well as individual customer level. This consists of certain steps, which are discussed as follows:
Firstly, activity dictionary needs to be formed, after which activity spending needs to be ascertained. Once it is ascertained, products, customers and services need to be identified and after this, activity cost drivers need to be chosen based on which activity rates could be computed.
Customer lifetime value (CLV)
The information gathered from these steps is used for evaluating the profitability from customer channel, profitability of various customer classes in a single channel and profitability of individual customers for the four biggest customers. With the help of this technique, the following benefits could be obtained:
Firstly, the profitable channel of industry and customers could be identified. Secondly, strategies could be developed for maintaining customers like maintain the arrangements of existing pricing (Hui, Liang & Yeung, 2018). Finally, minimisation of overhead as a significant strategy of mitigation is proposed for turning non-profitable customers into profitable customers.
This process initiates with the formulation of two matrices, which include list of products and significant activities related to distribution and production and allocating activities to the demands of the customers. The next stage is to carry out preliminary evaluation, in which ratings are provided to all activities (Irvine, Park & Y?ld?zhan, 2015). The customers are then related to each activity with consumption ranking. The next step is to detect those areas having average or high capital intensiveness with increasingly varying demands from various customers. Finally, the management of an organisation uses the outcomes of the analysis for formulating strategies in order to target detected areas for enhancing customers’ return on investment. With the help of this technique, the management could gain an overview of the overall picture of benefits obtained from the customers.
Based on the above evaluation, customer profitability analysis assists in mitigating certain issues, which are enumerated briefly as follows:
There are certain situations, in which the costs might be indirect. The ascertainment of the customers having lower gross margins is easier. Moreover, it is necessary to determine the customers paying greater gross margin; however, for them, different operational efforts are necessary for them. Therefore, the business organisations need to take into account the costs for servicing customers along with gross margin in order to avoid drainage of unnecessary costs (Kumar & Reinartz, 2018).
When the management of an organisation eliminates those clients having high maintenance, it provides additional time to the organisation in placing greater concentration on highly profitable customers. An effective strategy might be cross selling additional products to those customers valuing the relationship along with targeting new customers having similar characteristics like those of the good customers.
The merits of eliminating low-profit and high-maintenance customers would flow throughout the organisation. The sales department of an organisation is benefitted by concentrating on prospecting out the right customers valuing and paying for the products and services of the organisation. Finance and operations would recognise enhanced productivity in servicing those customers reasonable in their service demands (Mohammed, 2016). Hence, it could be stated that customer profitability analysis assists in enhanced profitability as well as cash flow. These are deemed to be the two components essential in growing an organisation at a rapid rate.
This technique is involved in analysing previous events depending on which strategic decisions are undertaken. However, the past trends might not follow up in future and hence; the business decisions might be incorrect. The acquisition and customer service cost is not easy to be measured. The performance of ABC could be a big undertaking for an organisation in relation to resources used and costs of finishing the initiative, needing specialised knowledge and developing accounting systems (Petersen et al., 2018).
For dealing with the limitations, it is necessary for the management to be sensitive to needed change within the organisation and ensure that the staffs are involved in the decision-making process. Moreover, the internal incentive model needs to be set appropriately in opposition to revenue generated from the end of the customers. For mitigating the backward-looking tool of CPA, customer lifetime value could be used as a base in the form of starting point for calculation.
Conclusion:
The above discussion clearly makes it apparent that customer profitability analysis allows the business organisations in disaggregating revenues and costs to individual product and customer levels for disclosing past hidden costs. Both ABC and ABM are used as strategic techniques for the management in order to accomplish certain goals. CPA is based on two foundations, which include activity-based costing system and the associated activity-based management. When the management of an organisation eliminates those clients having high maintenance, it provides additional time to the organisation in placing greater concentration on highly profitable customers. Certain limitations have been discussed in this paper and techniques to overcome the same have been elaborated as well.
References:
Bonacchi, M., Kolev, K., & Lev, B. (2015). Customer franchise—A hidden, yet crucial, asset. Contemporary Accounting Research, 32(3), 1024-1049. https://bia.unibz.it/bitstream/handle/10863/1419/preprint_Customer%20Franchise%20-%20A%20Hidden,%20Yet%20Crucial%20Asset.pdf?sequence=5
Brierley, J. A. (2016). An examination of the use of profitability analysis in manufacturing industry. International Journal of Accounting, Auditing and Performance Evaluation, 12(1), 85-102. https://eprints.whiterose.ac.uk/83953/8/WRRO_83593.pdf
Cambra-Fierro, J., Melero, I., & Sese, F. J. (2015). Managing complaints to improve customer profitability. Journal of Retailing, 91(1), 109-124. https://zaguan.unizar.es/record/56124/files/texto_completo.pdf
Faria, A. R., Ferreira, L., & Trigueiros, D. (2018). Analyzing customer profitability in hotels using activity based costing. Tourism & Management Studies, 14(3), 65-74. https://dialnet.unirioja.es/descarga/articulo/6577026.pdf
Fish, M., Miller, W., Becker, D. A., & Pernsteiner, A. (2017). The role of organizational culture in the adoption of customer profitability analysis: a field study. Qualitative Research in Accounting & Management, 14(1), 38-59. https://www.emeraldinsight.com/doi/abs/10.1108/QRAM-09-2015-0080
Hui, K. W., Liang, C., & Yeung, P. E. (2018). The effect of major customer concentration on firm profitability: competitive or collaborative?. Review of Accounting Studies, 29(3), 1-41. https://link.springer.com/article/10.1007/s11142-018-9469-8
Irvine, P. J., Park, S. S., & Y?ld?zhan, Ç. (2015). Customer-base concentration, profitability, and the relationship life cycle. The Accounting Review, 91(3), 883-906. https://aaapubs.org/doi/full/10.2308/accr-51246
Kumar, V., & Reinartz, W. (2018). Customer relationship management: Concept, strategy, and tools. Springer. https://books.google.co.uk/books?hl=en&lr=&id=NONaDwAAQBAJ&oi=fnd&pg=PR7&dq=Kumar,+V.,+%26+Reinartz,+W.+(2018).+Customer+relationship+management:+Concept,+strategy,+and+tools.+Springer.&ots=0XZozmoFgF&sig=EwcohscC30jg3wxb8ThwVW0VC0E#v=onepage&q=Kumar%2C%20V.%2C%20%26%20Reinartz%2C%20W.%20(2018).%20Customer%20relationship%20management%3A%20Concept%2C%20strategy%2C%20and%20tools.%20Springer.&f=false
Mohammed, S. S. (2016). Customer profitability analysis with time-driven activity-based costing: a case study in a hotel–Baghdad. Tikrit Journal For Administration & Economics Sciences, 12(34), 336-361. https://www.iasj.net/iasj?func=fulltext&aId=125847
Petersen, J. A., Kumar, V., Polo, Y., & Sese, F. J. (2018). Unlocking the power of marketing: Understanding the links between customer mindset metrics, behavior, and profitability. Journal of the Academy of Marketing Science, 46(5), 813-836. https://link.springer.com/article/10.1007/s11747-017-0554-5
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