Customer Profitability Analysis: Report on Modern Business Practices

This report provides a detailed analysis of Customer Profitability Analysis (CPA) in the contemporary business environment. It begins by highlighting the shift from product-oriented to customer-oriented strategies and introduces CPA as a crucial practice in management accounting. The report explores the foundations of CPA, including Activity-Based Costing (ABC) and Activity-Based Management (ABM), and their role in disaggregating revenues and costs to individual product and customer levels. It examines various CPA approaches such as Customer Lifetime Value (CLV), customer/channel profitability analysis, and customer return on investment. The report also discusses the benefits of CPA, including identifying profitable customers, enhancing productivity, and improving cash flow. Furthermore, it addresses the limitations of CPA, such as the reliance on past data and the challenges in measuring costs. Finally, the report suggests improvements to overcome these limitations and emphasizes the importance of CPA in making informed business decisions.

Running head: CUSTOMER PROFITABILITY ANALYSIS
Customer Profitability Analysis
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Table of Contents
Introduction:....................................................................................................................................2
Analysis of Customer Profitability Analysis (CPA):.......................................................................2
Limitations of Customer Profitability Analysis (CPA):..................................................................6
Improvement of Customer Profitability Analysis (CPA):...............................................................6
Conclusion:......................................................................................................................................6
References:......................................................................................................................................8

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Introduction:
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.
Analysis of Customer Profitability Analysis (CPA):
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:

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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:
Customer lifetime value (CLV):
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).
Channel or customer profitability:
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:

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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.
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.
Customers’ return on investment:
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 & Yıldızhan, 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.

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Based on the above evaluation, customer profitability analysis assists in mitigating
certain issues, which are enumerated briefly as follows:
Elimination of customers costing additional money:
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).
Focus:
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.
Enhanced productivity throughout the organisation:
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

6CUSTOMER PROFITABILITY ANALYSIS
cash flow. These are deemed to be the two components essential in growing an organisation at a
rapid rate.
Limitations of Customer Profitability Analysis (CPA):
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).
Improvement of Customer Profitability Analysis (CPA):
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

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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.

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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. http://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

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Irvine, P. J., Park, S. S., & Yıldızhan, Ç. (2015). Customer-base concentration, profitability, and
the relationship life cycle. The Accounting Review, 91(3), 883-906.
http://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