Session 6 B (Ch 14)

Customer Profitability Analysis

Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
 Learning Objectives

1. Discuss what is Customer Profitability Analysis

2. Discuss why a company’s revenues can differ across
customers purchasing the same product.
3. Discuss why customer-level costs differ across customers
4. Understand how an ABC system with a customer focus is
important for managing customers.
5. Perform Customer Profitability Analysis
6. Identify the importance of customer-profitability profiles
 Customer-Profitability Analysis
Identify by customers:
 Revenues earned from customers and the related costs
to earn the revenues.
 Reveals differences in the operating income earned from
different customers.
 Identify customers with different contributions to
operating income
 Determine appropriate action
 Customer-Revenue Analysis

Why revenues differ across customers purchasing the same

product
 The number of products purchased, and
 The magnitude of price discounting
 Customer-cost hierarchy
Five categories of indirect costs in customer-cost hierarchy:

1. Customer output unit-level costs—costs of activities to sell each unit to a

customer. E.g. Product-handling costs of each unit of product sold.

2. Customer batch-level costs—costs of activities related to a group of units sold

to a customer. E.g. costs incurred to process orders/ delivery cost

3. Customer-sustaining costs—costs of activities to support individual

customers, regardless of the sales volume, e.g. costs of visits to customers

4. Distribution-channel costs—costs of activities related to a particular

distribution channel rather than to specific customers. E.g. salary of the
distribution manager

5. Division-sustaining costs—costs of division activities that cannot be traced to

individual customers or distribution channels. E.g. salary of Division manager.
 Customer-Cost Analysis
Which of these customer-level Indirect costs should be considered in
customer cost analysis?
 customer output unit–level costs,
 customer batch-level costs, and
 customer-sustaining costs.

Why?
 Customer actions will have more impact on customer-level (indirect)
costs
Compare - distribution-channel and division-sustaining costs
 Examples of customer level costs and cost drivers

• Examples of customer level costs and cost drivers:

Customer Level cost Cost Drivers

Order taking Number of orders

Product handling Number of cases
Rush order processing Number of rush orders
Number of units
Exchange and repair costs
exchanged/repaired

• To some extent, we can use activity-based to analyse customer profitability

 An Example - 14-32 Customer profitability
 Antelope Manufacturing makes a component called A1030. This component is
manufactured only when ordered by a customer, so Antelope keeps no inventory of
A1030.

 The list price is $115 per unit, but customers who place “large” orders receive a 12%
discount on price. The customers are manufacturing firms. 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. 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 A1030 is $95. In addition, Antelope

incurs customer-level costs. Customer-level cost-driver rates are:

Order taking $360 per order

Product handling $15 per case
Rush order processing $560 per rush order

Exchange and repair costs $50 per unit

 14-32 Customer profitability

Information about Antelope’s five biggest customers follows:

A B C D E
Number of units purchased 5,400 1,800 1,200 4,400 8,100
Discounts given 12% 12% 0 12% 12% on half the units
Number of orders 8 16 52 20 16
Number of cases 540 180 120 440 810
Number of rush orders 1 6 1 0 5
Number of units exchanged/repaired 14 72 16 40 180

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.

1. Calculate the customer-level operating income for these five customers. Prepare a customer-
profitability analysis by ranking the customers from most to least profitable.

2. Discuss the results of your customer-profitability analysis. Does Antelope have unprofitable
customers? Is there anything Antelope should do differently with its five customers?
 14-32 Calculation of Revenue By customer

A B C D E
Revenues at list price

$115 × 5,400; 1,800; 1,200; 4,400; 8,100 $621,000 $207,000 $138,000 $506,000 $931,500

Price discount 74,520 24,840 0 60,720 55,890

12% × $621,000; 12% × $207,000; 0; 12% ×
$506,000; 12% × (8,100 × 50%) × $115
Revenues (actual price) 546,480 182,160 138,000 445,280 875,610
14-32 Calculation of Gross Profit Margin by customer

Customer
A B C D E
Revenues at list price
$115 × 5,400; 1,800; 1,200; 4,400; 8,100 $621,000 $207,000 $138,000 $506,000 $931,500
Price discount 74,520 24,840 0 60,720 55,890
12% × $621,000; 12% × $207,000; 0; 12% ×
$506,000; 12% × (8,100 × 50%) × $115
Revenues (actual price) 546,480 182,160 138,000 445,280 875,610

Cost of goods sold 513,000 171,000 114,000 418,000 769,500

$95 × 5,400; 1,800; 1,200; 4,400; 8,100
Gross margin 33,480 11,160 24,000 27,280 106,110

Gross margin Percentage 5.39% 5.39% 17.39% 5.39% 11.39%

 Customer-Level Costs

Revenues (actual price) 546,480 182,160 138,000 445,280 875,610

Customer-level costs: A B C D E
Order taking
2,880 5,760 18,720 7,200 5,760
$360 × 8; 16; 52; 20; 16
Product handling
8,100 2,700 1,800 6,600 12,150
$15 × 540; 180; 120; 440; 810
Rush order processing
560 3,360 560 0 2,800
$560 × 1; 6; 1; 0; 5
Exchange and repair
700 3,600 800 2,000 9,000
$50 × 14; 72; 16; 40; 180

Total customer-level costs 12,240 15,420 21,880 15,800 29,710

Total customer-level costs/Net Revenue 2.24% 8.47% 15.86% 3.55% 3.39%

 14-32 Customer profitability by customer

Customer
A B C D E
Revenues at list price
$115 × 5,400; 1,800; 1,200; 4,400; 8,100 $621,000 $207,000 $138,000 $506,000 $931,500
Price discount
12% × $621,000; 12% × $207,000; 0; 12% × $506,000; 74,520 24,840 0 60,720 55,890
12% × (8,100 × 50%) × $115

Revenues (actual price) 546,480 182,160 138,000 445,280 875,610

Cost of goods sold 513,000 171,000 114,000 418,000 769,500

$95 × 5,400; 1,800; 1,200; 4,400; 8,100
Gross margin 33,480 11,160 24,000 27,280 106,110

Gross margin Percentage 5.39% 5.39% 17.39% 5.39% 11.39%

Customer-level costs: A B C D E
Order taking
2,880 5,760 18,720 7,200 5,760
$360 × 8; 16; 52; 20; 16
Product handling
8,100 2,700 1,800 6,600 12,150
$15 × 540; 180; 120; 440; 810
Rush order processing
560 3,360 560 0 2,800
$560 × 1; 6; 1; 0; 5
Exchange and repair
700 3,600 800 2,000 9,000
$50 × 14; 72; 16; 40; 180

Total customer-level costs 12,240 15,420 21,880 15,800 29,710

Total customer-level costs/Net Revenue 2.24% 8.47% 15.86% 3.55% 3.39%

Customer-level operating income $21,240 ($4,260) $2,120 $11,480 $76,400

Customer-level operating income/ Net Revenue 3.89% -2.34% 1.54% 2.58% 8.73%
 Questions to Answer

 Please review the results of your customer-profitability analysis and

discuss about your findings? Please consider the followings:
 Which customers are profitable and which are not
 Reasons that the customer not profitable?
 Any ways for improvements?
 What about other customers which may need attention? For
example, customer B, customer C, and customer E.
 Analysis of Individual Customers
Customer B - Only unprofitable customer. All other customers are
profitable in line with revenue.
 Giving discounts on small size of orders - 16 orders out of $ 207
K revenue
 Costly - process many small orders as opposed to a few large
orders.
How to become profitable customer
 Place fewer, larger orders and
 Offer a price discount only for larger size order;
 Also - many rush orders (total 6) in proportion to total number
of orders
 Find a production schedule - meet its needs without having to
rush the order.
 Analysis of Individual Customers
Customer E
 Many rush orders (5) and large number of units exchanged/repaired
(180) that are costly
 Align its production schedule to Customer E’s needs and
 Reduce the number of units exchanged/repaired.
Customer C
 Low operating income/operating income as a percentage of
revenues.
 A large number of small orders (52) and gets no price discounts
 Reduce the number of orders - take price discounts on large
orders
Customer Ranking / Customer Profile

Cumulative
Customer-Level
Customer-Level Operating Income as
Operating Cumulative a % of Total
Customer-Level Customer Income Customer-Level Customer-Level
Customer Operating Income Revenue Divided by Revenue Operating Income Operating Income
Code (1) (2) (3) = (1) ÷ (2) (4) (5) = (4) ÷ $106,980
E $ 76,400 $ 875,610 8.73% $ 76,400 71.42%

A 21,240 546,480 3.89% $97,640 91.27%

D 11,480 445,280 2.58% $109,120 102.00%

C 2,120 138,000 1.54% $111,240 103.98%

B (4,260) 182,160 −2.34% $106,980 100.0%

Total $106,980 $2,187,530

 Customer-Profitability Profiles
 Cumulative customer-profitability profiles - operating income each
additional customer contributes
 80-20 rule
 Whale Curve
 Help managers to explore ways to make unprofitable customers
profitable
Other factors considered
 Likelihood of customer retention.
 Potential for sales growth.
 Long-run customer profitability.
 Increases in overall demand from having reference customers.
 Ability to learn from customers.
 Customer-profitability profiles
Whale Curve of Cumulative Customer Profitability
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