Foster, G.M. Gupta and L. Sjoblom. 1996. Customer Profitability Analysis: Challenges and New Directions. Journal of Cost Management (Spring): 5-17.
Summary by Matthew Hoffman
Master of Accountancy Program
University of South Florida, Fall 2001
Customer Profitability Main Page | Performance Measurements Main Page
This article presents
the concept of modifying cost accounting systems in order to provide
measurements from a customer profitability viewpoint.
Although many companies publicly claim to hold the customer as the most
important factor in business, the cost accounting systems of these organizations
do not reflect this. Most
management accounting systems focus on “products, departments or geographical
regions”, which have little to do with customers.
Through responses to a survey, companies describe their views on
capturing customer profitability measures, as well as attributes and
deficiencies in their current cost models and business practices.
Degrees of Focus on Customer Account Profitability
profitability (CAP) can be looked at from many different contexts.
At the lowest level, a company can look at the profitability of
individual customers. This would be
ideal for firms selling products or services to a few, large customers. A company could group customers together based on certain
similar characteristics such as size of average transaction, business size,
number of transactions, etc. This
might be useful if the company has numerous customers and cannot capture data
individually due to the enormous costs it would require.
Should Companies Use CAP?
Companies must realize that “each dollar of revenue does not contribute equally to income.” Differences in the characteristics of relationships between the company and its many customers can account for dramatic discrepancies in CAP. The authors give some examples of things that can affect this:
1. Revenue differences
2. Differences in cost
3. Differences in distribution channels
4. Differences in customer service levels
business’ management accounting system should be able to measure the effects
of each of these. This will provide
management with the necessary information to make important decisions.
Activity based costing can help a firm immensely with measuring customer
profitability. However, if the company finds that changing its processes
will increase profitability in the long-run, the ABC system will require
companies have a unique issue. Firms
with large service infrastructure, such as hotels and transportation providers,
usually have well developed and defined levels of service available to
customers. While firms with small
infrastructure such as law firms can tailor their services to better fit
individual customers. The companies
with large infrastructure will not be able to practically provide custom
services to individual customers because the ensuing effect up the distribution
chain would become enormous.
The authors list the following features that make CAP analysis invaluable:
1. It follows through the entire value chain.
2. It focuses on multiple transactions of a customer.
3. It emphasizes multiple products that a customer purchases.
4. It can separate costs so that they are customer-specific or aggregated to whatever level management desires.
Companies replying to the survey consistently pointed out that their current systems would be unable to measure this type of data. Therefore, new systems would be required to support management.
Challenges facing businesses that want to adopt CAP
The many challenges
that face a business that wants to adopt CAP are numerous.
As mentioned before, systems will need to be put into place to
accommodate the measurement of pertinent data.
Management will need to focus on what estimates will be needed.
Current decisions can immediately incur costs that the business will not
realize for years to come. Estimates
must be able to foresee these costs. Future
profitability analyses will have to take into account multiple time horizons.
For instance, a customer that is unprofitable through the next three
years might become enormously profitable five years from now.
Finally, management will be influential in developing the many drivers
associated with the customer costs. Decisions
must be well researched and thoroughly thought through.
As companies realize the potential benefits of measuring customer profitability, many opportunities will open up. CAP will affect strategic decisions, the valuing of intangible assets, and customer retention rates will be improved through CAP analysis. Using intangible assets as an example, business will realize the enormous future impact that current actions can have on assets such as brand name or customer base. Although there are many practical problems in taking a CAP approach, the authors feel that the future benefits will more than make up for issues that must be resolved.