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.
Different Degrees of Focus on Customer Account Profitability
Customer account 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.
Why 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
A 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 constant updating.
Service 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.
Key Features of CAP Analysis
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.
Conclusions
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.
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Related summaries:
Guilding, C. and L. McManus. 2002. The incidence, perceived merit and antecedents of customer accounting: An exploratory note. Accounting, Organizations and Society 27(1-2): 45-59. (Summary).
Howell, R. A. and S. R. Soucy. 1990. Customer profitability: As critical as product profitability. Management Accounting (October): 43-47. (Summary).
Manning, K. H. 1995. Distribution channel profitability. Management Accounting (January): 44-48. (Summary).
Martin, J. R. Not dated. Product life cycle management. Management And Accounting Web. (Summary).