The Importance of a Customer Profitability Analysis in Today’s Market

Businesses across all industries have been significantly impacted by cost increases in 2022. In the Philadelphia region, inflation is up 8.8 percent according to the Bureau of Labor Statistics. These increases have not only been evident in product and material costs, but also labor and other service-driven expenses.

Although many businesses have been able to pass on some of the costs to their customers, many times these increases are not uniform across a customer base, nor are they for the full amount of costs absorbed. The result is often a moderate increase in revenue but higher material and labor costs, resulting in shrinking gross profits.

In these situations, companies face two scenarios: 1) they can try to bridge the gap by generating new business to cover the gross profit shortfall, or 2) they can attempt to further increase prices to existing customers without putting customer relationships at risk.  If a company cannot generate additional margins using the second option because of price competition, then that leaves a company grappling with the first option. However, if the company cannot source enough materials and labor to serve new customers—a fairly common occurrence given supply chain challenges and the tight labor market—then performing a customer profitability analysis can help a company focus its limited resources on its most profitable customers.

Although a customer profitability analysis should be performed regularly, it is paramount in today’s market due to the scarcity of resources. In addition to the quantitative approach of analyzing margins by product lines, accounts receivable turnover, and growth potential, businesses should also take a qualitative look at their customers – which ones continually make unrealistic demands, take up excessive employee time, or always require re-work? All of these factors are important in today’s market where every employee hour matters, both from a production and an employee satisfaction aspect.

The results of a customer profitability analysis can have two significant and positive outcomes:

  1. Gives a clear picture of how best to allocate resources. Many times, the production team handles orders as they are placed, and the earliest order gets filled first. But this may not necessarily be the best approach for the company. A customer with high profit margins, high volume, and a good qualitative score should be tended to first; since these are the customers that are essential to retain and the foundation for the company’s continued success. Customers on the other end of this spectrum, however, may be expendable, and should be serviced only when the needs of the high-scoring customers are met. Alternatively, companies may choose to implement new reduced service levels to lower-scoring customers in an effort to reduce the cost of serving those customers, freeing up resources for higher-scoring customers.
  2. Reducing resources devoted to lower-scoring customers creates capacity for new customers. We are not advocating abandoning customers on a whim, because long-term customer loyalty is very important. However, every business has at least a handful of customers that have generated lower than expected volumes over a long period of time.  Obtaining accurate historical data and routinely reviewing that data to make tough decisions about those customers is essential if a company is facing resource constraints.

There is an employee-related intangible associated with customer retention decisions as well. In today’s tight labor market, high employee satisfaction is critical, and one way to have an impact is to reduce the amount of time they spend serving problematic customers, particularly those who always have issues with the product and require employees to do re-work. Employees will be more engaged if they are doing meaningful work that customers value, not low-skill work that provides a lower level of job satisfaction.

If your business is experiencing material shortages and delays and labor constraints, a customer profitability analysis could provide the data management needs to improve profitability despite the resource constraints and inflationary pressures almost every business currently faces. Better yet, making tough decisions today will help build a foundation for even stronger performance when the business environment finally returns to normal.

Steven Feimster can be reached at Email or 215.441.4600.

 

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