Customer profitability analysis

Customer profitability analysis

Main objective of this study is to determine the impact of activity based costing(ABC) on the  customer profitability analysis (CPA). Previous studies have examined the importance of customer profitability without checking the potential usefulness of ABC to develop CPA.

Customer profitability analysis can use for any income increases by using any strategic decision, such as change of delivery term of a contract up to terminate business dealings of unprofitable customer. 

Researchers state that if customer related cost can be reduced without any change for customer experience or while maintaining the quality of the product or service, there is a impact on customer profitability. It is necessary to distinguish the characteristics profitable from unprofitable customers.  

Researchers have identified four expense categories impacting on customer profitability

1.Purchasing Patterns  and customer profitability

2. Delivery Policy and customer profitability

3. Accounting Procedure and customer profitability

4. Inventory holding and customer profitability

According to the  activity based concepts are paramount important to focus on customer profitability. There are three types of customers who are potentially unprofitable however might be retained

(1)  New and growing customers, who promise profitable business in the future and may provide a stepping stone for penetrating lucrative new markets;

(2) Customers providing qualitative rather than financial benefits, including customers at the edge in the development of new markets who provide valuable insights into likely trend movements in consumer demand;

(3) Customers providing increased capability because of their status as recognized leaders in their markets or fields of expertise.

Researchers request to negotiate with customers to influence the behavior in a way it is profitable to organization without compromising customer satisfaction.  Improved negotiations might include

Non-cash incentives from sunk-cost investments –

Restructure of delivery runs to create a more timely but less frequent service for the customer;

Capacity maximization on delivery runs that are required for profitable customers by offering a more frequent service for the potentially unprofitable customer with unpredictable demands;

Purchase of equipment on behalf of customers which they can use rent-free, in lieu of discounts and/or agent’s commissions. The cash saved on reduced discounts/commissions potentially should exceed the cost of the asset. Additionally, ownership is retained and a stronger bond is forged with the customer, thereby generating greater negotiating power in future;

Free short-term financial advice which will create efficiencies for the customer, leading to reduced internal workload and consumption of resources;

New products at no cost in return for reduced discounts, to serve a dual purpose: improving customer profitability while providing a useful vehicle for the promotion of new products;

A trade-off between quantity discounts and settlement discounts that minimize the costs of cash overdraft and maximize long-run production scheduling.

The most important point of customer profitability analysis is that management should aware about the unprofitable customers and make more attention in developing strategies to minimize the losses or make the customer profitable without reducing the customer satisfaction.

Resources allocation to activities provide clearer picture of resources consumption by customers. Using activity drivers will assist to assign activity cost to customers. Turney and Stratton developed an activity-based model using micro and macro activities which easily assign the cost to final products.

Customer costing objective – depicting the profitability of a customer using the cost of macro activities;

Performance improvement objective – isolating detailed areas for potential improvement by focusing on micro activities.

How ABC important to Sri Lankan Companies

If you look at Asia’s top 100 companies, top 100 brands, etc there is hardly any Sri Lankan companies in the list. Countries who are less developed than Sri Lanka like Pakistan, Vietnam even have some presence. We have failed due to so many reasons. One main reason is Sri Lanka does not have sustainable product or services to offer to the world. We are unable to compete with the low price high quality products in the market.

Only a few Sri Lankan companies practice the activity based costing which directly supporting to total quality management (TQM), 5-S system etc.  Practicing ABC costing will provide manufactures or service provider some clear picture about high cost pools. So they can attack high cost areas by adding high technology, streamline the processers, bringing new concepts, product modification, outsourcing etc.  Sometimes they may have more involve in low cost pools which is not adding value. This also help to enhance the quality or practice  total quality management.

ABC costing helps to take product pricing decisions. Such as the final price to customer. Whether to continue or discontinue the production. whether to produc the product or make outsourcing. Keep the particular customer drop the customer. Etc. Management can use this  ABC costing to make above decisions.

Companies can use the ABC costing data for budgeting purposes. Since it gives more accurate cost information and accurate customer profitability analysis. Further it improves the budgets and same can be used to measures of department and division performance.

ABC costing helps in effective utilizing the scares resources and make the input cost low. It focus more on profitable customers and cost centers which lead to make product cost low. Hence it generates more sales and with less efforts with the improved quality. 

Any barriers to implement it in Sri Lanka

Most of the Sri Lankan companies, specially management is not aware about ABC costing principles and they do not understand the benefits which can obtain. Hence there is some resistance from Management to implement ABC costing in their organizations.

ABC costing is more time consuming for implementing and to collect data. It’s a systematic and lengthy process. Also there is less people available with required knowledge to implement and practice ABC costing.

If a company is trying to purchase, implement and maintain an activity based system, the initial cost is huge. Hence it is much difficult to implement for smaller organizations.

Some companies have complicated process.  Establishing the causes and effects and the relationship between cost driver and final product costs is difficult and unclear.

ABC does not conform to generally accepted accounting principles in some areas.