CUSTOMER

PROFITABILITY
ANALYSIS

F.M.KAPEPISO
LEARNING OBJECTIVES
At the end of the lecture, you should be able to:
 Explain the importance of customer profitability
analysis
 Prepare different customer profitability reports
 CUSTOMER PROFITABILITY DEFINED
 Customer profitability analysis refers to the reporting
and analysis of customer revenues and customer costs.
 Customer profitability analysis draws heavily on
allocation of indirect costs to customers using Activity
Based Costing approach.
 From the company’s point of view it is important to know
how much a customer contributes to its profit and how
much it costs to service his expectations.
 Managers need to ensure that customers contributing
sizably to the profitability of an organization receive a
comparable level of attention from the organization, in
order to attract and retain profitable customers.
 CUSTOMER REVENUE ANALYSIS
 Customer revenues are inflows of assets from customers
received in exchange for products or services being provided
to those customers.
 This requires accurate calculation of revenues earned from various
customers and the analysis is enhanced by retaining as much details
as possible about revenue (such as list selling price, price discount
and actual selling price)
 Revenue of customer purchasing the same product can differ due to
quantity purchased and discounts from list price
 A key concern is price discounting, which is the reduction of selling
prices below listed levels in order to encourage an increase in
purchases by customers. It facilitate further analysis that could
examine which customer had price discounting and which sales
representatives most frequently resorted to price discounting.
 Giving the actual price only precludes such systematic analysis of
price discounting
 CUSTOMER COSTS ANALYSIS
 A company must also look at the costs involved with servicing various
customers. Implementing ABC cost approach helps identifying
customer costs more precisely.
 Outline of an ABC system (revision lesson); the major ideas behind
ABC are as follows:
 Activities cause costs. Activities include ordering, materials handling,
machining, assembly, production scheduling and dispatching
 Producing products creates demand for the activities
 Costs are assigned to a product on the basis of the product’s consumption of
the activities
 ABC operate as follows:
 Identify an organisation’s major activities
 Identify cost drivers (factors influencing the level of costs or factors which link
activity resource consumption to product outputs e.g. number of purchase
order would be a cost driver to procurement cost)
 Collect costs associated with each cost driver into cost pool (grouping of costs
related to a particular activity)
 Charge the costs of each cost pool to products on the basis of their usage of the
activity
 CUSTOMER COSTS ANALYSIS
 A customer cost hierarchy categorises costs related to
customers into different cost pools on the basis of
different types of cost drivers as follows (Horngren, 2012):
 Customer output-unit level costs – costs of activities to sell
each unit of product or a service to a customer e.g. transport
 Customer batch-level costs – costs of activities related to a
group of units sold to a customer e.g. delivery
 Customer-sustaining costs – costs of activities to support
individual customers regardless of the quantity ordered by the
customer e.g. installation
 Distribution-channel costs – costs of activities related to a
particular distribution channel rather than to each unit or batch
or specific customer e.g. salary of distribution manager
 Corporate-sustaining costs – costs of activities that cannot be
traced to individual customers or distribution channels
 CUSTOMER PROFITABILITY REPORTS
 Customer profitability analysis reports that are useful for
an organisation include:
 Customer-level profitability analysis – analyse the revenue including cost
of goods sold and costs incurred in the first three categories of the customer
cost hierarchy e.g. customer output-level costs, customer batch-level costs and
customer sustaining costs
 Statement of profit or loss – analyses customer level profitability and
include the last two categories of the customer hierarchy e.g. distribution
channel costs and corporate-sustaining costs
 Customer profitability profiles – is actually ranking of customers based on
profit earned from them and helps to direct attention to more valuable
customers. Strategic decisions aimed for retaining customers or acquiring new
customers should take into account other factors such as:
1. Customer loyalty
2. Potential for sales growth
3. Snowball effect
4. Customer feedback
 CUSTOMER PROFITABILITY REPORTS
Example 1
The following table shows five activities (in addition to cost of goods
sold) that Voyages identifies as resulting in customer-level costs. The
table indicates the cost drivers and cost drivers rates for each activity
as well as the cost-hierarchy category for each activity. Voyages
distribution buys bottled water from Voyages Products at $0.50 a bottle.

Activity Cost driver and rate Cost-hierarchy category

Order taking $100 per purchase order Customer batch-level costs
Custumer visits $80 per customer visit Customer-sustaining costs
Delivery vehicles $2 per delivery mile travelled Customer batch-level costs

Product handling $0.02 per bottle sold Customer output-unit level costs
Expedited deliveries $300 per expedited delivery Customer batch-level costs
 CUSTOMER PROFITABILITY REPORTS
Example 1…
The following are the details for sales and related activities:
Customer
A B C D
Bottles sold 1 000 000 800 000 70 000 60 000
List selling price $0.60 $0.60 $0.60 $0.60
Actual selling price $0.56 $0.59 $0.55 $0.60
Number of purchase orders 30 25 15 10
Number of sales visits 6 5 4 3
Number of deliveries 60 30 20 15
Kilometres travelled per delivery 5 12 20 6
Number of expedited deliveries 1 0 2 0

Required:
a) Prepare a customer-level profitability analysis
b) Prepare the statement of profit and loss. Assuming Voyages Distribution has
distribution-channel costs of $33 396 and corporate sustaining costs $25 715
c) Prepare a customer profile based on revenues and profits
 SUGGESTED SOLUTION (EXAMPLE 1(A))
A B C D TOTAL
Revenue at list price 600,000 480,000 42,000 36,000 1,158,000

less: discount (40,000) (8,000) (3,500) - (51,500)

Revenue at actual price 560,000 472,000 38,500 36,000 1,106,500

Less: Cost of goods sold (500,000) (400,000) (35,000) (30,000) (965,000)

Gross profit 60,000 72,000 3,500 6,000 141,500
Less: Customer-level operating costs -

order taking (3,000) (2,500) (1,500) (1,000) (8,000)

customer visits (480) (400) (320) (240) (1,440)

delivery vehicles (600) (720) (800) (180) (2,300)

product handling (20,000) (16,000) (1,400) (1,200) (38,600)

expedited deliveries (300) - (600) - (900)

Total customer-level operating
costs (24,380) (19,620) (4,620) (2,620) (51,240)

Customer-level operating profit 35,620 52,380 (1,120) 3,380 90,260

Baseline Manufacturing makes a component called P14-31. This component is
manufactured only when ordered by a customer, so Baseline keeps no inventory of P14-31.
The list price is $100 per unit, but customers who place “large” orders receive a 10%
discount on price.
Currently, the salespeople decide whether an order is large enough to qualify for the
discount. When the product is finished, it is packed in cases of 10. When a customer order
is not a multiple of 10, Baseline uses a full case to pack the partial amount left over (e.g., if
customer C orders 25 units, three cases will be required). Customers pick up the order so
Baseline incurs costs of holding the product in the warehouse until customer pick up.
The customers are manufacturing firms; if the component needs to be exchanged or
repaired, customers can come back within 10 days for free exchange or repair. The full cost
of manufacturing a unit of P14-31 is $80. In addition, Baseline incurs customer-level costs.

Customer-level cost-driver rates are as follows:

Order taking $390 per order
Product handling $10 per case
Warehousing (holding finished product) $55 per day
Rush order processing $540 per rush order
Exchange and repair costs $45 per unit

Information about Baseline s five biggest customers follows:

A B C D E
Number of units purchased 6,000 2,500 1,300 4,200 7,800
Discounts given 10% 0 10% 0 10% on half of the
units
Number of orders 10 12 52 18 12
Number of cases 600 250 120 420 780
Days in warehouse (total for all 14 18 0 12 140
orders)
Number of rush orders 0 3 0 0 6
Number of units exchanged/repaired 0 25 4 25 80

The salesperson gave customer C a price discount because, although customer C ordered
only 1,300 units in total, 52 orders (one per week) were placed. The salesperson wanted to
reward customer C for repeat business. All customers except E ordered units in the same
order size. Customer E’s order quantity varied, so E got a discount part of the time but not
all the time.

Required:
1. Prepare a customer-profitability analysis and rank the customers from most to least
profitable.
2. Discuss the results of your customer-profitability analysis. Does Baseline have
unprofitable customers? Is there anything Baseline should do differently with its five
customers?
Thanks