Customer Profitability: A One Way Street

Accountants love to tick and tie numbers, and sometimes become insanely excited when their numbers balance. This insanity is to their advantage when they are providing their “Control” function. In case others reading this article don’t know, accountants have multiple roles or functions in business. One is “Control” – Make sure money and assets are where they’re supposed to be. Another is “Advisor” – Providing information essential to making good management decisions.

Back to our insane asylum – This attention to detail, cross-referencing, and balancing serves their business well in their “Control” function. However, when it comes to providing decision grade information for management in their “Advisor” role, this insanity drives others insane. This time the insanity is not welcome.

For an example, let’s look at customer profitability.  Accountants are slowly getting the message that there is a cost to serve customers beyond what it costs to produce products. They are beginning to recognize that a sales representative serves their customer’s needs with a portfolio of products. Rarely are sales representatives dedicated to a single product. Instead, they call on customers to understand their needs. Then they try to meet those needs with whatever product best matches their customers’ requirements.

From a cost perspective, this means we can trace cost to serve to customers but not to products. We have a good cause and effect relationship between sales and the customer. But we don’t have a relationship between sales to products. When the sales call is made, we don’t know what product the customer will buy. An insane accountant will attempt to allocate these sales costs to products.

A good “Advisor” accountant will recognize where cause and effect relationships exist and where they don’t. The “Advisor” will trace product costs to products and customer costs to customers. But the “Advisor” will not stop there. The “Advisor” will create a customer profitability statement. The top of this statement will highlight the revenue earned from the customer with the corresponding costs of products. This will provide the customer’s gross margin. Then the advisor will list all the activities required to serve the customer that are not product related. Remember that the product related costs were included in the top section. Once these cost to serve activities are deducted from the customer gross margin, we’ll see what this customer relationship contributes to covering other business costs and hopefully (essentially) a bottom line profit.

To summarize on our one-way street, customer costs flow down one lane. Products costs come in from a side street, and then flow down a lane alongside the customer costs. These two lanes unite in a customer profitability analysis. However, allocating customer costs to products is going against traffic on a one-way street. It is dangerous. Going against traffic consistently is insane.