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The Customer Profitability Minefield
Despite its importance in CRM, customer profitability has always been a challenge for software applications to analyze because of the many unexpected external factors that are introduced by individual customer behavior.
Posted Jul 10, 2000
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The hot mantra for customer relationship management (CRM) is customer profitability. If you want to identify which of your customers are profitable and which are not, and implement a strategy for each, then you should invest in a new CRM system. So says the literature from almost every software company in the market.

This got me thinking about the qualities of customer profitability. At its most basic, it is the difference between revenues and cost, on a per customer basis. There's nothing difficult about that. However, an example will illustrate what a minefield profitability analysis can be.

Let's say you have two customers, George and Karen. Each orders £10,000 worth of Product A every month. Given that they are ordering identical products, then, as long as they each order the same volume of goods, George and Karen are equally profitable to you.

But no two customers are the same. George takes his order of Product A in one monthly shipment. Karen wants hers shipped in four weekly installments. Although revenues from each customer and the cost of procuring, manufacturing and shipping Product A remain the same, the service cost for the second customer is higher than for the first.

Next you must take into account the fact that Karen has a discount on her purchases because she also buys £10,000 worth of Product B every month. By now, in terms of Product A, Karen looks very unprofitable compared with George, until you remember that the only reason you have George's account is because you send him on an all expenses paid trip to Spain to play golf each year.

You must also consider the manufacturing cost of Product B, which Karen buys but George does not. Product B is unprofitable to make. It would be cheaper to buy in the product from the Far East but you'd rather not have to close down the factory. And what about the fact that George is late paying his bills, and needs to be chased by credit control, whereas Karen pays promptly?

By now, it is hard to tell which customer is the more profitable. Such complications make profitability analysis a nightmare. It is hard work keeping track of the factors affecting the profitability of any one of your customers.

A Profitability Panacea?
still, the software industry loves a challenge, especially if it involves making money as well. Ten years ago, it offered its solution for profitability analysis: buy a system that caters for everything your business does. It had to be a single integrated system that tied together all your activities: manufacturing, distribution, procurement, finance and reporting. Since these systems did everything, they contained all the information needed to piece together a profitability view of each customer.

This vision sold billions of dollars' worth of ERP software and related services around the world in less than a decade. But now customers are realising it is difficult to understand customer profitability with these systems, for several reasons.

The systems, despite the hype from both software vendor and consultant, did not do everything. They did not track customer interactions, such as George needing his ticket to Spain for next week. In fact, they knew nothing about George, or Karen, or any of your other customers, except for the raw transactional data: what goods, how much, when, where, and so on.

That's when the CRM software companies realised that a rich seam was waiting to be mined. Companies had bought the customer profitability story without reaping the benefits. In theory, all you needed to do was insert a system which understood the customer, and you would have plugged the biggest gap in the ERP system.

However, none of these CRM systems know whether somebody has paid their bills or how long it takes to extract payment. Or whether the product is worth being made in-house or bought in. Or what the real cost is of being George's supplier of Product A.

Those blessed with a grounding in accountancy will tell you that the only genuine analysis of profitability is one that takes the activities that lead to profits into account. That way, you have a view of the cost of shipping Karen her goods four times as often as George. This tells you that the kind of system you need puts together an ERP system plus a CRM system plus an activity-based costing (ABC) system. Such systems do exist, but they don't work well together. So you also need a TEC, or truly expensive consultant, to build your path to customer understanding.

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