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What is Customer Profitability Analysis?

Vendavo< Vendavo January 3, 2022

Customer profitability analysis enables a business to understand the true value of its customers, through careful evaluation of – you guessed it – their profitability. 

It’s a method that’s now widely used by companies hoping to gain a better understanding of how much revenue each customer, or group of customers, generates. 

Exploring customer profitability analysis can provide numerous benefits to businesses. Not only does it allow companies to market themselves more effectively, but it can also help to improve long-term retention rates by facilitating highly targeted and more cost-effective strategies. Here’s how it works. 

Customer Profitability 101

The profitability of a customer can be evaluated relatively easily – providing a company has all the relevant data to hand. Without it, organizations may find themselves left in the dark.

Calculating customer profitability relies on knowing the following:

  • Total annual revenue generated by the customer
  • Timeframe the customer will spend purchasing products or services

The annual profit of a customer can then be found simply by subtracting the cost of serving a customer over the course of a year from the revenue that they have brought to the company in that time. 

Revenue might include the recurring revenue of a customer through repeat purchases, increased profits through upgrades or premier subscription services, and boosts in profitability due to cross-buying across different product ranges. When looking at expenses, you’ll need to think about auxiliary costs too such as loyalty scheme costs and operational expenses. 

Customer Profitability Analysis: Essential for Revenue Growth

When companies take the time to understand customer profitability on an individual basis, it puts them in a stronger position to make better-judged decisions relating to margin growth.

Customer retention schemes can be managed more effectively using customer profitability analysis. The information obtained via this analysis enables companies to focus their retention efforts and thereby improve their success rate and the return on investment of these strategies. 

With data obtained via customer profitability analysis, companies can segment customers into distinct groups, and make better use of personalization when marketing to these groups. Marketers will therefore be able to maximize the potential return of every interaction, while also showing different customer groups how valued they are by the brand. 

Read: Why is Profitability Analysis so Important?

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Running a Customer Profitability Analysis

To, run a customer profitability analysis, a company will need to examine a series of important profitability metrics. Typically, this data will be readily available. 

  • Segment customers

Teams running a profitability analysis will need to calculate customer costs, including the expenses we mentioned earlier, and they’ll also need to know how these differ across customer groups. To understand this, customer data should be segmented into distinct groups. Profitability analysis can then be completed using the information held on these customer groups. 

  • Gather the data

Once customer profitability calculations have been completed, teams will have much better visibility on the real value of different customer groups, taking into account the costs involved in retaining certain customers, and the profitability that they bring to the business as a whole. Calculations are only as reliable as the data that informs them, so it’s also a good idea to examine the technology used to record this data, and the availability of historic transaction data, before completing customer profitability analysis.  

  • Put it all together

Customer profitability data can be presented using profitability curves. This method sees customer data sorted by net profit, then displayed as a curve from most profitable to least. By displaying data in this way, teams can easily see which groups of customers are most profitable – and therefore most worthy of their retention efforts. 

What To Do With The Results

The results of customer profitability analysis are sometimes surprising, but it’s best to exercise some caution before acting on your findings. 

It’s best to exercise some caution before acting on your profitability analysis findings. 

Don’t be too hasty in discarding less profitable customer groups. Such actions can sometimes have unexpected, knock-on effects on your company’s revenue stream. Instead, focus on the customers who are proven to bring in the best value for your company. Think about further strategies you might employ to retain these customers, and start looking into acquisition strategies for similar prospective buyers to boost your business in the long term. 

Review your discount policies in light of what you now know about customer profitability, ensuring your company is well placed to extract the maximum possible profit from existing customers. 

You might also want to think about any potential revenue leakages at this point. Are there any points in your buying journey where you might be losing out on profits? Consider whether your minimum order value could be raised, or how else you might eliminate any missed opportunities to improve profitability. 

A Vital Calculation to Undertake

Customer profitability analysis should always be seen as a method and a process, rather than an all-encompassing solution. But that doesn’t mean it can’t help to inform the decisions that might lead to these solutions. 

Profitability analysis is a vital calculation for companies that are serious about revenue growth. But for it to be used to its full advantage, companies need easy access to all relevant data. Businesses should therefore be making full use of available pricing technology to capture and leverage data more intelligently. 

The results of calculations should of course be acted on quickly. Data revealed by such analysis can also be used to help inform all team members on new revenue opportunities, leading to more highly targeted and more successful growth strategies moving forward. And those are goals well worth the effort, aren’t they?

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