This article aims to present a methodology for analyzing the profitability of customers based on the analysis of the cost of serving. Its structure was divided into two complementary parts:
- Part 1 – Motivations and Methodology: In this first part, the main motivators for structuring the profitability analysis based on the calculation of the cost of serving will be raised. In addition, a suggested methodology for its development, implementation and maintenance will be detailed;
- Part 2 – Analysis of Results and Conclusions: the second part of the work will describe how to interpret the results of the analysis and how to unfold them into action plans and strategies internally that would seek to improve the company's financial result. Finally, a list with the main conclusions that can be drawn from the profitability analysis is placed to direct the efforts of those who will have access to this work.
PART 1
MOTIVATIONS
The increased level of demand on the part of consumers is causing companies to reassess their management models and start paying greater attention to the development and maintenance of practices aimed at the relationship with their customers.
Delivering the product within the agreed timeframe, developing an efficient fault remedy system, maintaining a well-trained after-sales team and having commercial and logistical flexibility are now as important as supplying the product with the agreed quality and at competitive prices in the market. .
Thus, the structuring of a customer profitability analysis process based on the measurement of service costs, in a more comprehensive approach, which takes into account not only production costs, but also logistical and commercial ones, has been gaining fundamental importance. importance for companies to be able to measure, analyze, develop customized service policies and, consequently, optimize their profits.
This process is a tool applicable to the vast majority of companies, but mainly to those with a wide variety of products and service channels, where customers or segments are heterogeneous and differentiated requirements for pre- or post-sales services are required. Any of these characteristics make the analysis of customer profitability gain importance for directing your strategy.
The following factors can be cited as the main benefits of this analysis:
- Measurement of the financial return of each company's client, allowing decision-making to be based on quantitative factors;
- Mapping of the various costs of the company, which allows understanding which processes are the most costly to serve the customer (logistic, commercial or production) and where it is necessary to act to optimize its profit;
- Basis for directing commercial policies, such as price definition, bonuses, promotions, merchandising, minimum orders, etc.;
- Basis for targeting customer segmentation and developing commercial strategies based on costs and profitability;
The motivation for structuring a process for calculating customer profitability is to analyze whether the level of service being offered is giving the expected return. When the analysis is carried out, it can be seen that those with a low cost of serving are not always more profitable for the company. On the other hand, it is also not right to say that the ones that bring the most revenue to the company are the most profitable.
According to Kaplan and Cooper (1998), understanding customer profitability as a function of the cost to serve is an alternative to “Porter's warning” in relation to not trying to build a low-cost operation simultaneously with product differentiation and high levels of service. of service. By analyzing the cost to serve, the company can seek to be profitable in all types of customers, low cost or high differentiation.
Despite this scenario and the numerous benefits that a process with these characteristics can result in, it is still common for companies to measure their financial results only based on how much customers contribute to revenue or total margin. However, these forms of measurement lead managers to a little detailed view and do not provide many inputs so that more specific decisions can be taken.
There is no research that quantifies why few companies still have a well-structured process for calculating the cost of serving and analyzing profitability. However, it is possible to raise some factors that may justify the low adherence to the practice.
One of these factors is the organizational structure of companies and how it is configured to serve the customer. Despite there being an evolution in this sense, there are still not many that have cells of Customer Service and most of them operate on a “supply supply” regime. push”). In this configuration, quantifying the analysis gains, and giving value to this type of process, is more difficult. However, even in those more customer-oriented (“demand pull”), profitability analysis is not so widespread, since managers are not clear on how to carry it out and what actions to take after discovering that part of their portfolio is profitable and part is not.
Another factor that may justify the low use of this type of process is the cost and time that companies have to spend to structure it and keep it updated. Mapping costs, understanding apportionment drivers, collecting data, creating data collection and updating systems are steps that can generate additional complexities in companies' routines and, many times, they are not prepared to mobilize internal resources to develop the process.
The following topics seek to minimize the impact of these factors that hinder the implementation of this process by describing a methodology for creating and maintaining the process and detailing possible analyzes that can be carried out to guide companies' action plans.
METHODOLOGY
The analysis of customer profitability based on a survey of service costs should not be seen as a project, but rather as a process made up of several complementary stages that must be reviewed and improved at each cycle carried out. Figure 1 shows the steps that make up the methodology for creating and maintaining the process, and how they are linked together to reach the final result, divided into three main phases: Decision, Development and Results.
Figure 1 – Phases and stages of the customer profitability analysis process
First Phase – Decision
The objective of this first phase is to identify the motivations and the value to be obtained from the creation of a profitability analysis process. In addition, possible financial impacts are quantified and concepts are disseminated about what the process is.
At this stage, an important decision to be made is who will be responsible for both the development and maintenance phases of the process. It must be decided whether the development of the process will be done internally or with the help of a third party and which company team will be responsible for keeping the process working after its first cycle.
If the option to develop internally is chosen, it must be clear that it is a process that requires a lot of effort on the part of the team that is developing and it is quite complex to carry out this task in parallel with other internal initiatives. In addition, it is necessary to select a team that is free to communicate with different areas within the company. This is because, for the full development of the process, it is necessary to go into details of costs, in some confidential cases, and the team needs to have the freedom and maturity to deal with them. To define the team responsible for maintaining the process, the same precautions must be taken.
If you choose to outsource the process development phase, in addition to selecting a good supplier, you must dedicate a person as the company's focal point who has extensive knowledge of the operation and who is able to communicate both at an operational and strategic level. These characteristics are necessary to help third parties from the initial stage, mapping costs, to the preparation of action plans.
Still at this stage, it is important to seek the engagement of all those who will be impacted by the process, but especially the leadership. Starting the development phase with the commitment of the leaders is essential to build a process that adheres to the main guidelines of the organization. In addition, its deployment and future maintenance tends to be facilitated.
Second Phase - Development
In the Development phase, what will be the costing object, which and how the costs of serving this object will be mapped, what will be the apportionment drivers of the raised costs and which IT systems will be used to calculate and maintain the process of profitability analysis of customers running after its development.
The definition of the costing object will determine what will be measured and managed by the company. Leadership needs to be clear about the level of detail it needs to be able to make decisions and what information is available to be able to carry out the analysis. As it is a process, it can be concluded that for future rounds, new information will be necessary to improve the quality of information, implying investments or IT developments. After this consideration, the most common costing objects can be: customers, segments, service channels and even products.
Deciding to carry out a profitability analysis per customer is to opt for the highest level of detail, which despite generating greater complexities in structuring and maintaining the methodology, is the level that will provide greater visibility, and this will provide a greater basis for decision making.
On the other hand, the analysis of profitability by product can bring good directions from the point of view of defining the portfolio and positioning strategy of certain products, including being able to guide the decision to discontinue a product or product line.
It is important to remember that both analyzes can be performed. By crossing the profitability of products with the profitability of customers, it is possible to have a very valuable level of information for making different strategic decisions, but the effort of generating numbers and analyzing information will also be quite large.
Having made the decision on the costing object, the next step is to survey the costs associated with that object, that is, what are the costs of serving that object. This step requires a broad investigation of the company's operation and how its various areas are structured to serve the customer.
Serving costs consist of all costs required to provide the product to the customer, considering all the cycle steps of their order cycle. Both costs directly linked to the activity of serving the customer and indirect costs that are necessary to maintain the business must be included. Costs can be classified into three categories:
- Costs of Goods Sold: costs related to the manufacturing process (raw material, production lines, production shifts, etc.) or purchase of the product (acquisition cost, freight, etc.) that will be supplied.
- Customer Service Costs: costs related to the activity of serving the customer, from the stage of selling and advertising the product to delivery at the final point and provision of after-sales services. Marketing, sales and logistics activities should be considered in this category.
- Business Fixed Costs: costs that are not directly linked to customers, but which are indispensable for maintaining the business. Included in this account are IT costs, executive salaries, patents, cleanliness and security, etc.
Fixed business costs may or may not be part of the analysis. If it is decided to include them, as they are not costs arising from the activity of serving the customer, they must be worked on carefully, so that the result at the end of the analysis is not misinterpreted. It is necessary to know that if the client has a negative profitability, its withdrawal from the portfolio will not result in the elimination of these fixed costs. On the other hand, not including them can reduce the level of detail of the analysis and affect the quality of the action plans drawn up. One way of dealing with this issue is to segregate how much fixed cost is part of the total cost of serving each customer.
This is a step that must be highly customized and worked on in great detail so that the company's reality is well represented through the selected costs. Figure 2 shows a possibility of organizing service costs into Sales Costs and Logistics Costs and some examples of accounts that should be taken into account.
Figure 2 – Example of classification of service costs
Having mapped the costs that will be used in the profitability analysis, it is necessary to quantify them. This stage requires a lot of interaction between the team responsible for developing the process and the company's IT and Finance team.
Some difficulties can be faced during its realization, because the information will not always be consolidated in a single system, or else some have a high degree of confidentiality. Despite this, at the end of this step, each of the mapped costs must be quantified so that in the next step they can be apportioned to each of the customers.
When quantified, it is already possible to begin to understand which are the main cost accounts of the company. From what can be called the company's cost map, the development team is already able to draw some conclusions and direct efforts in the following stages.
The next step in the process development phase is mapping the drivers of apportionment and allocation of costs to the company's customers. This is a complex stage of the process, as it requires a detailed study of each of the costs raised, seeking to understand how it is possible to dilute them in a coherent way to how much each of the customers demanded from the analyzed account.
Depending on how the information is available, some costs may be allocated directly to the company's customers. For example, sales bonus costs and the purchase of space in stores are usually separated and their allocation is easier and more direct. However, for most costs it is necessary to make an apportionment.
Generally, this analysis is based on the activity-based costing methodology (ABC – Activity Based Costing). However, some studies suggest the use of a concept that was called time-driven ABC. The basic difference is that this model uses the time spent on each activity as a driver of activity costs (eg time a salesperson spends at the customer's to take the order).
As this is a costly process, it is recommended that, from the quantified cost map, the most representative ones be identified and these are chosen to have a greater level of detail and investigation in this apportionment stage. Disregarding the representativeness of costs and treating everyone the same way can make the process unfeasible in terms of time and cost.
At the end of this stage, the costs are apportioned for each of the company's customers.
Still in this development phase of the process, two other stages are essential: the survey and integration of information technology systems. Although they are not decisive for reaching a first response from the profitability analysis, carrying out these steps allows the company to perform the process again, automatically, within a defined period.
Part of these steps are:
- Decision to purchase software to support the process or build en casa of a tool
- Creation of data integration and transaction platforms between the different origins of the cost bases that will supply the tool
- Programming of apportionment logics in the system
- Creation of automated reports and analyzes that will help the company in the stages of analysis of results and preparation of action plans.
It is also important to take into account in these steps how flexible the tool for calculating customer profitability will be. Since the analysis will take place at various times, it is necessary to create ways to incorporate possible customer entries and exits into the platform, changes in cost centers and other improvement opportunities raised in each of the cycles so that the process becomes increasingly robust.
These last two stages of the Development phase are not necessary for the third Results phase to start, but they are requirements for the process to be automatically replicated in the future.
A robust system would also be capable of carrying out simulations of changes in product values, costs or even customer entry or exit, arriving at parameters that can bring “optimal” profitability. In addition, it could be configured to perform sensitivity analyzes that indicate the impacts of cost reduction efforts or price changes.
All these additional functionalities to the selected system have an impact on additional costs for its development, but they end up adding enough value so that, in the Results phase, the company can draw up action plans with a lot of visibility of its cost of serving customers.
Third Phase - Results
The third and final phase of the process is Results. Once the analysis methodology has been developed, it is possible to calculate the profitability of each client, analyze the results and, most importantly, define plans and strategies that will allow the company to leverage its profits.
The calculation of profitability is a less complex step than the previous ones. Once the costing rules are well elaborated, the company will only need to raise the revenue that each of the clients generated in the period of analysis and compare it with the calculation of the cost generated by each one. Figure 3 shows, in a simplified way, how the profitability calculation should be done.
Figure 3 – Example of calculating customer profitability
Once the profitability of each customer has been calculated, it is possible to see which ones have negative and positive profitability and which are close to the break-even point (contribution margin = 0).
From these results that the most complex step begins: the analysis of results. With the information in hand, it will be possible to understand whether there is a subsidy between customers, the return of certain logistical and commercial strategies and the cost of different levels of service offered to different customers, among other various business factors.
In general, the visibility that a cost-of-service analysis brings is very high, and may even be uncomfortable for some managers. You may find that some large customers have negative profitability, marketing initiatives are reducing the business margin, and offering higher service levels to less profitable ones.
The leadership must keep in mind that, from now on, it has a powerful tool for decision-making at all levels: strategic, tactical and operational, and that the most important thing is what actions will be taken to better adjust the client portfolio and logistical, productive and commercial practices to the company's strategic direction.
Still in this last stage of preparing the action plans, it is important to have a final discussion of what were learned and opportunities for improvement identified for the next cycle of analysis. The customer profitability analysis process is a continuous improvement cycle. Each time it is carried out, the tendency is for the level of information generated to be more accurate than the previous cycle.
Therefore, having leadership engagement, having developed a tool that supports the process and having detailed and formalized costing rules are key factors for the results obtained to be the best possible and for the company to be able to base its decisions.
In order to assist managers in decision-making, and due to the importance they have in the process, the second part of the article will discuss in more detail the stages of analysis of results and preparation of action plans. In addition, at the end of the text some conclusions are listed to make clear the benefits and precautions that must be taken when implementing a process of this type.
