Page 156 - Marketing Management

CREATING LONG-TERM LOYALTY RELATIONSHIPS | CHAPTER 5 133

It’s not always the company’s largest customers, who can demand considerable service and deep
discounts, who yield the most profit. The smallest customers pay full price and receive minimal
service, but the costs of transacting with them can reduce their profitability. Midsize customers
who receive good service and pay nearly full price are often the most profitable.

Customer Profitability
A profitable customer is a person, household, or company that over time yields a revenue stream
exceeding by an acceptable amount the company’s cost stream for attracting, selling, and serving
that customer. Note the emphasis is on the lifetime stream of revenue and cost, not the profit from
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a particular transaction. Marketers can assess customer profitability individually, by market seg-
ment, or by channel.
Many companies measure customer satisfaction, but few measure individual customer prof-
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itability. Banks claim this is a difficult task, because each customer uses different banking services
and the transactions are logged in different departments. However, the number of unprofitable
customers in their customer base has appalled banks that have succeeded in linking customer
transactions. Some report losing money on over 45 percent of their retail customers.
CUSTOMER PROFITABILITY ANALYSIS A useful type of profitability analysis is shown in
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Figure 5.3. Customers are arrayed along the columns and products along the rows. Each cell
contains a symbol representing the profitability of selling that product to that customer. Customer
1 is very profitable; he buys two profit-making products (P1 and P2). Customer 2 yields mixed
profitability; he buys one profitable product (P1) and one unprofitable product (P3). Customer 3
is a losing customer because he buys one profitable product (P1) and two unprofitable products
(P3 and P4).
What can the company do about customers 2 and 3? (1) It can raise the price of its less profitable
products or eliminate them, or (2) it can try to sell customers 2 and 3 its profit-making products.
Unprofitable customers who defect should not concern the company. In fact, the company should
encourage them to switch to competitors.
Customer profitability analysis (CPA) is best conducted with the tools of an accounting tech-
nique called activity-based costing (ABC). ABC accounting tries to identify the real costs associ-
ated with serving each customer—the costs of products and services based on the resources they
consume. The company estimates all revenue coming from the customer, less all costs.
With ABC, the costs should include the cost not only of making and distributing the products
and services, but also of taking phone calls from the customer, traveling to visit the customer, pay-
ing for entertainment and gifts—all the company’s resources that go into serving that customer.
ABC also allocates indirect costs like clerical costs, office expenses, supplies, and so on, to the activ-
ities that use them, rather than in some proportion to direct costs. Both variable and overhead costs
are tagged back to each customer.
Companies that fail to measure their costs correctly are also not measuring their profit correctly
and are likely to misallocate their marketing effort. The key to effectively employing ABC is to
define and judge “activities” properly. One time-based solution calculates the cost of one minute of
overhead and then decides how much of this cost each activity uses. 45

Customers |Fig. 5.3|
C 1 C 2 C 3
Customer-Product
Highly profitable Profitability Analysis
P 1 + + +
product
Profitable
P 2 + product
Products
P 3 – – Unprofitable
product
P 4 – Highly unprofitable
product
High-profit Mixed-bag Losing
customer customer customer