Customer profitability analysis is a method widely used by companieshoping to gain a better understanding of how much revenue each customer, or group of customers, generates. It enables a business to understand the true value of its customers, through careful evaluation of their profitability.
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. This analysis can be done in spread sheets or more easily with a purpose built profit analyzer solution.
Revenue might include therecurring 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.
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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.
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.
About The Author
David Anderson is a Boston-based Business Consultant with Vendavo. Since 2001 he has led and consulted on pricing & commercial process transformation at some of the world’s largest companies. After joining Vendavo in 2016, he has specialized on driving value & outcomes with Vendavo’s high tech, medical device, and process industry customers. Dave is a manufacturing process engineer by training (BS, MSE from Kettering, Purdue), and received his MBA from Harvard Business School.