A customer P&L sheet allows companies to determine the appropriate level of service, as well as pricing, discounts, and distribution.
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Exceed customer expectations. Delight the customer. The customer is always right. We're a customer-driven organization.
Each of those platitudes can destroy a brand.
How? Customers cost money to acquire, service, and retain. If you spend more money "delighting" customers than they are worth, eventually your brand is out of business.
To thrive, companies must be able to calculate customer profitability as part of the process of determining customer equity. Unfortunately, calculating customer profitability requires more than simply totaling sales. What's needed is a P&L (profit-and-loss) statement for each customer that's based on the following formula: gross revenues less customer allowances less credits and rebates less product costs less channel costs less cost-to-serve less administrative costs equals customer profit.
A customer P&L sheet is as important as a P&L sheet for the corporation. A customer P&L sheet is at the heart of any customer relationship program. Without it, the relationship may be based on false and unprofitable pretenses. A customer P&L sheet allows companies to determine the appropriate level of service, as well as pricing, discounts, and distribution. It also indicates where to allocate resources for the greatest return. It pinpoints savings in processes and provides a road map for aligning sales force compensation with true customer value. A customer P&L sheet can even tell you when to "fire" a customer.
A customer P&L sheet helps achieve a fundamental business goal, which is not to build sales or market share, but to increase profitability. For example, Roadway Express, a national trucking firm, operates in an industry whose margins average a paltry 2.5 percent. The industry is unforgiving of mistakes. Consolidated Freight, the nation's third-largest hauler, just went out of business. Last year, Roadway turned away more than 350,000 tons of business, because it was able to calculate that the cost of service exceeded the new revenue. Sales went down, but Roadway's revenue-per-ton increased by 4 percent.
Roadway is able to make more money shipping fewer goods because it creates customer P&Ls using activity-based costing (ABC). This lets Roadway calculate the actual costs of specific activities for particular customers, down to the dollar.
"We see [ABC] as a competitive advantage," CIO Robert Obee says. "We know the difference in profitability between different services, so we know how to grow our profitability. That can lead us to move away from, or not emphasize, certain types of business."
Traditional accounting measures only the cost of goods and such expenses as labor, but ABC measures the cost of processes across an organization. ABC breaks down every process into its component activities. For example, loading a truck for delivery may include knowing the time and other resources required to palletize cartons, operate a forklift, number cartons, and even finish the paperwork.
ABC analysis starts by determining whether organizational activities are value- or nonvalue-added. Value must be directly related to customer requirements. Nonvalue-added activities are those required by the organization, such as an inventory report.
The next step is linking costs from across the organization, not just within a department, to those activities. By contrast, traditional accounting allocates direct and indirect costs based on arbitrary formulas, which can result in some products appearing to be profitable when they are actually being subsidized by other offerings.
To build a customer P&L sheet
Start with the easy stuff: Assign cost-of-capital to individual customers by looking at accounts receivable and finished-goods inventory balances. Often, these costs can be lowered during customer consultations once calculations are in hand.
Move to the next level: A customer P&L statement starts by looking at activities in six categories: sales, ordering, production, shipping, collections and returns, and postsales support. Issues include the number of sales calls required to close, ordering preference (Web, phone, etc.), frequency of order changes, type, and frequency of post-sales support, etc.
Segment customers by profitability: Segmentation strategies also must apply to existing customers. Categorize customers into groups according to profitability. Those at the top of the list probably deserve more attention and service than those at the bottom. Work to increase the profitability of lower-ranked customers.
Consider intangibles, too: Consider the value if a customer is in a strategic growth area, or if a customer evangelizes your firm to others.
Know how customers rate you: Ask customers how they rate you in such areas as credit terms, quality, price, service, support, reliability, and accommodation of special requests. High ratings indicate additional business in the future. Ideally, customers who give you the highest ratings should correlate to high-profit customers. If not, you may be spending too much time on less-profitable customers and not enough on your best customers.
Share data with customers: Show customers your P&L sheet for them. Tell them it's a road map for improving the relationship, and help them understand the impact of their demands. One potential result is, the customer may agree to higher prices for smaller orders, and bigger discounts for larger orders.
It's not enough to say the customer is number one. You have to know which customer is number one--and who are numbers two, three, four, and five.
About the Author
Nick Wreden is a customer loyalty expert and speaker with more than 20 years of experience in branding. His most recent book is FusionBranding: How to Forge Your Brand for the Future, which examines how customer equity, operational excellence, and accountability are the new branding imperatives. Contact him at email@example.com or 770-582-6791.