Number 21: Winter 2003

 

Building a customer P & L

By Nick Wreden

Editor's note: Gaining as many customers as possible may sound like an attractive proposition but this may not be the case if it costs more to service the customer than the revenue that they generate. The creation of a profit & loss account for individual customers can help to identify those that should be "fired."

Exceed customer expectations. Delight the customer. The customer is always right. We're a customer-driven organization.

Each of those platitudes can destroy a brand.

How? Customers cost money to acquire, service and retain. If you spend more money "delighting" customers than they are worth, eventually your brand is out of business. 

To thrive, companies must be able to calculate customer profitability as part of the process of determining customer equity. Unfortunately, calculating customer profitability requires more than simply totaling sales. What's needed is a P&L (profit and loss) statement for each customer that's based on the following formula: gross revenues less customer allowances less credits and rebates less product costs less channel costs less cost-to-serve less administrative costs equals customer profit.

A customer P&L sheet is as important as a P&L sheet for the corporation. A customer P&L sheet is at the heart of any customer relationship program. Without it, the relationship may be based on false ­ and unprofitable ­ pretenses. A customer P&L sheet allows companies to determine the appropriate level of service as well as pricing, discounts and distribution. It also indicates where to allocate resources for the greatest return. It pinpoints savings in processes and provides a roadmap for aligning salesforce compensation with true customer value. A customer P&L sheet can even tell you when to "fire" a customer. 

A customer P&L sheet helps achieve a FusionBrand's fundamental goal, which is not to build sales or market share, but to increase profitability. For example, Roadway Express, a national trucking firm, operates in an industry whose margins average a paltry 2.5%. The industry is unforgiving of mistakes. Consolidated Freight, the nation's third-largest hauler, just went out of business. Last year, Roadway turned away more than 350,000 tons of business because it was able to calculate that the cost of service exceeded the new revenue. Sales went down, but Roadway's revenue-per-ton increased by 4%. Roadway is able to make more money shipping fewer goods because it creates customer P&Ls using ABC (activity-based costing). This lets Roadway calculate the actual costs of specific activities for particular customers, down to the dollar. 

"We see [ABC] as a competitive advantage," says Roadway CIO Robert Obee. "We know the difference in profitability between different services, so we know how to grow our profitability. That can lead us to move away from, or not emphasize, certain types of business."

While traditional accounting measures only the cost of goods and such expenses as labor, ABC measures the cost of processes across an organization. In many ways, ABC resembles the "scientific management" pioneered a century ago by Frederick Taylor, who stalked assembly lines with a stopwatch in his classic time-and-motion studies.

ABC breaks down every process into its component activities. For example, loading a truck for delivery may include knowing the time and other resources required to palletize cartons, operate a forklift, number cartons and even finish the paperwork.

ABC analysis starts by determining whether organizational activities are value- or non value-added. Value must be directly related to customer requirements. Non value-added activities are those required by the organization, such as an inventory report.

The next step is linking costs from across the organization ­ not just within a department ­ to those activities.  By contrast, traditional accounting allocates direct and indirect costs based on arbitrary formulas, which can result in some products appearing to be "profitable" when they are actually being subsidized by other offerings.

To build a customer P&L sheet:

  • Start with the easy stuff: Assign cost of capital to individual customers by looking at accounts receivable and finished-goods inventory balances. Often, these costs can be lowered during customer consultations once calculations are in hand.

  • Move to the next level: A customer P&L statement starts by looking at activities in six categories: sales, ordering, production, shipping, collections and returns, and post-sales support. Issues include the number of sales calls required to close, ordering preference (Web, phone, etc.), frequency of order changes, type and frequency of post-sales support, etc.

  • Segment customers by profitability: Segmentation strategies also must apply to existing customers. Categorize customers into groups according to profitability. Those at the top of the list probably deserve more attention and service than those at the bottom. Work to increase the profitability of lower-ranked customers.

  • Consider intangibles, too: Consider the value if a customer is in a strategic growth area, or if a customer evangelizes your firm to others.

  • Know how customers rate you: Ask customers how they rate you in such areas as credit terms, quality, price, service, support, reliability, accommodation of special requests and other areas. High ratings indicate additional business in the future. Ideally, customers who give you the highest ratings should correlate to high-profit customers. If not, you may be spending too much time on less-profitable customers and not enough on your best customers. 

  • Share data with customers: Show customers your P&L sheet for them. Tell them it's a roadmap for improving the relationship, and help them understand the impact of their demands. One potential result: The customer may agree to higher prices for smaller orders, and bigger discounts for larger orders. 

It's not enough to say that "the customer is number one" to establish a FusionBrand. You also have to know who is number one . . .  and who are numbers two, three, four and five. 

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© Nick Wreden / Through the Loop Consulting Ltd 1998-2003