CUSTOMER

PROFITABILITY
ANALYSIS
F.M.KAPEPISO

LEARNING OBJECTIVES

At the end of the lecture, you should be able to:

Explain the importance of customer profitability
analysis
Prepare different customer profitability reports

CUSTOMER PROFITABILITY DEFINED

Customer profitability analysis refers to the reporting
and analysis of customer revenues and customer costs.
Customer
profitability analysis draws heavily on
allocation of indirect costs to customers using Activity
Based Costing approach.
From the companys point of view it is important to know
how much a customer contributes to its profit and how
much it costs to service his expectations.
Managers need to ensure that customers contributing
sizably to the profitability of an organization receive a
comparable level of attention from the organization, in
order to attract and retain profitable customers.

CUSTOMER REVENUE ANALYSIS

Customer revenues are inflows of assets from customers

received in exchange for products or services being provided
to those customers.
This requires accurate calculation of revenues earned from various
customers and the analysis is enhanced by retaining as much details
as possible about revenue (such as list selling price, price discount
and actual selling price)
Revenue of customer purchasing the same product can differ due to
quantity purchased and discounts from list price
A key concern is price discounting, which is the reduction of selling
prices below listed levels in order to encourage an increase in
purchases by customers. It facilitate further analysis that could
examine which customer had price discounting and which sales
representatives most frequently resorted to price discounting.
Giving the actual price only precludes such systematic analysis of
price discounting

CUSTOMER COSTS ANALYSIS

A company must also look at the costs involved with servicing various
customers. Implementing ABC cost approach helps identifying
customer costs more precisely.
Outline of an ABC system (revision lesson); the major ideas behind
ABC are as follows:

Activities cause costs. Activities include ordering, materials handling,

machining, assembly, production scheduling and dispatching
Producing products creates demand for the activities
Costs are assigned to a product on the basis of the products consumption of
the activities

ABC operate as follows:

Identify an organisations major activities

Identify cost drivers (factors influencing the level of costs or factors which link
activity resource consumption to product outputs e.g. number of purchase
order would be a cost driver to procurement cost)
Collect costs associated with each cost driver into cost pool (grouping of costs
related to a particular activity)
Charge the costs of each cost pool to products on the basis of their usage of the
activity

CUSTOMER COSTS ANALYSIS

A customer cost hierarchy categorises costs related to

customers into different cost pools on the basis of different
types of cost drivers as follows (Horngren, 2012):

Customer output-unit level costs costs of activities to sell

each unit of product or a service to a customer e.g. transport
Customer batch-level costs costs of activities related to a
group of units sold to a customer e.g. delivery
Customer-sustaining costs costs of activities to support
individual customers regardless of the quantity ordered by the
customer e.g. installation
Distribution-channel costs costs of activities related to a
particular distribution channel rather than to each unit or batch
or specific customer e.g. salary of distribution manager
Corporate-sustaining costs costs of activities that cannot be
traced to individual customers or distribution channels

CUSTOMER PROFITABILITY REPORTS

Customer profitability analysis reports that are useful for

an organisation include:

1.
2.
3.
4.

Customer-level profitability analysis analyse the revenue including cost

of goods sold and costs incurred in the first three categories of the customer
cost hierarchy e.g. customer output-level costs, customer batch-level costs and
customer sustaining costs
Statement of profit or loss analyses customer level profitability and
include the last two categories of the customer hierarchy e.g. distribution
channel costs and corporate-sustaining costs
Customer profitability profiles is actually ranking of customers based on
profit earned from them and helps to direct attention to more valuable
customers. Strategic decisions aimed for retaining customers or acquiring new
customers should take into account other factors such as:
Customer loyalty
Potential for sales growth
Snowball effect
Customer feedback

CUSTOMER PROFITABILITY REPORTS

Example 1

The following table shows five activities (in addition to cost of goods
sold) that Voyages identifies as resulting in customer-level costs. The
table indicates the cost drivers and cost drivers rates for each activity
as well as the cost-hierarchy category for each activity. Voyages
distribution buys bottled water from Voyages Products at $0.50 a bottle.
Activity

Cost driver and rate

Cost-hierarchy category

Order taking

$100 per purchase order

Customer batch-level costs

Custumer visits

$80 per customer visit

Customer-sustaining costs

Delivery vehicles

$2 per delivery mile travelled Customer batch-level costs

Product handling

$0.02 per bottle sold

Expedited deliveries $300 per expedited delivery

Customer output-unit level costs

Customer batch-level costs

CUSTOMER PROFITABILITY REPORTS

Example 1

The following are the details for sales and related activities:

Customer
A

Bottles sold

1 000 000

800 000

List selling price

$0.60

$0.60

$0.60

$0.60

Actual selling price

$0.56

$0.59

$0.55

$0.60

Number of purchase orders

30

25

15

10

Number of sales visits

Number of deliveries

60

30

20

15

Kilometres travelled per delivery

12

20

Number of expedited deliveries

Required:

70 000

D
60 000

a)

Prepare a customer-level profitability analysis

b)

Prepare the statement of profit and loss. Assuming Voyages Distribution has
distribution-channel costs of $190 000 and corporate sustaining costs $263 000

c)

Prepare a customer profile based on revenues and profits