Management And Accounting Web

Howell, R. A. and S. R. Soucy. 1990. Customer profitability: As critical as product profitability. Management Accounting (October): 43-47.

Summary by James Cline
Master of Accountancy Program
University of South Florida, Summer 2002

ABC Main Page | ABM Main Page | Customer Profitability Main Page

The 1980’s was a decade of customer satisfaction due to increasing competition on this continent and overseas. The authors say that during the 1990’s it will be just as important for companies to know customer profitability, as it is to know product profitability. During the late 1980’s computers were beginning to take on greater roles of tracking all sorts of costs, and systems were being developed to ease the labor-some tasks of costing. Activity based costing was becoming a major player in product costing and product profitability during the product development and manufacturing stages, but the authors said that that was only half the job. Whatever costing method is used, the decision whether or not to discontinue a product is not made solely on the cost input. Customer issues are taken into consideration. A company that produces many products may have a few that are not profitable, but because they are produced, they attract customers that are highly profitable on other products. A company’s resources are not only used by products, but by customers, markets, and channels of distribution as well. The following are some examples:

Volume discounts,
Sales support,
Inventory and distribution support,
Inventory holding requirements,
Freight policies,
Credit and collection support,
Accounts receivable,
Order entry and customer support, and
Field service.

These costs are generally considered period costs as selling, general, and administrative expenses (S, G, & A); and represent between 20% - 40% of the sales costs in some Fortune 500 companies. Even though much of these costs could be assigned directly to products, since GAAP does not disallow their assignment to products or customers, they are instead built on top of the product as part of the mark-up over cost. Accounting for the S, G, & A expenses in this manner may cause a company to continue producing a product or continue serving a customer that is not overall profitable to the company.

In order to determine a customer’s profitability an analysis must be done that assigns the revenues, expenses, assets, and liabilities of an organization to the customers who cause them. This is called Resource Costing and is done in a few simple steps using a company’s value chain profile. The value chain profile typically includes four stages: product development, manufacturing, distribution, and sales & marketing. The first two are product related, and the second two are customer related.

First, assign the costs to products (stages 1 & 2). The customer is then charged properly by applying the costs against the customer’s mix.

Second, assign the customer’s expenses and assets that are driven by the distribution and marketing and sales process.

Third, define which resources are driven by activities designed to support the customer.

Fourth, the resources are then analyzed and assigned to customers, markets, or channels of distribution.

The first option is always to assign the costs directly to customers. However, if resources cannot be identified directly with a customer, it is often possible to identify the resource either with different markets to which a company sells. The third possibility of assignment of costs is to establish resources supporting different channels of distribution.

The next step is to assign costs to the customers on the basis of activities. Costs assigned to markets or channels of distribution may be assigned to customers based on the activities that drive the cost (i.e. sales calls). There may be some activities that cannot be assigned to the customers, markets, or channels. To assign those costs properly the best possible cost driver must be selected. This type of cost can then be assigned to customers based on their buying patterns.

The final step is to use other information gathering techniques to take the costs still assigned to markets or channels of distribution and reassign those costs to the customers. Assignment of all costs in this manner would allow a company to invest more in a customer that is highly profitable, drop a customer that does not generate enough revenues to justify the expenses required to support it, or address excessive expenses to make a customer more profitable. The authors suggest that understanding the customer/cost relationship is critical for companies as they attempt to differentiate themselves from their competitors on a service level as well as a product level going into the 1990’s.

Nine Box Profile

The "nine box profile" is referred to as "an analytical tool used to gain understanding about a company's customer diversity" (p. 44). The table below shows the idea where there are nine combinations, e.g., high margin with high volume, high margin with medium volume etc.


High Volume Medium Volume Low Volume
High Margin\No. Customers Margin\No. Customers Margin\No. Customers
Medium Margin\No. Customers Margin\No. Customers Margin\No. Customers
Low Margin\No. Customers Margin\No. Customers Margin\No. Customers

Customer Profitability Statement

A new type of profit and loss statement has been developed to create a customer profit and loss profile. This analysis allows management to prepare a micro strategy to increase the profitability of each customer. On the macro level, a company can evaluate channel of distribution and market profitability and develop a plan for cost reduction and improved profitability.

In many companies there is a pull of resources to the largest customers. Instead, management needs to reassign resources to activities and customers that will yield more sales, greater customer service, and higher profits.


Related summaries:

Adamany, H. G. and F. A. J.Gonsalves. 1994. Life cycle management: An integrated approach to managing investments. Journal of Cost Management (Summer): 35-48. (Summary).

Artto, K.A. 1994. Life cycle cost concepts and methodologies. Journal of Cost Management (Fall): 28-32. (Summary).

Clinton, B. D. and A. H. Graves. 1999. Product value analysis: Strategic analysis over the entire product life cycle. Journal of Cost Management (May/June): 22-29. (Summary).

Czyzewski, A. B. and R. P. Hull. 1991. Improving profitability with life cycle costing. Journal of Cost Management (Summer): 20-27. (Summary).

Donelan, J. G. and E. A. Kaplan. 1998. Value chain analysis: A strategic approach to cost management. Journal of Cost Management (March/April): 7-15. (Summary).

Foster, G., M. Gupta and L. Sjoblom. 1996. Customer profitability analysis: Challenges and new directions. Journal of Cost Management (Spring): 5-17. (Summary 1). (Summary 2).

Gordon, L. A. and M. P. Loeb. 2001. Distinguishing between direct and indirect costs is crucial for internet companies. Management Accounting Quarterly (Summer): 12-17. (Summary).

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).

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).