The active management of the client portfolio, focusing on the accounts that make the greatest contribution to the company's profitability, is a highly valuable instrument, as it allows the correct allocation of available resources, in addition to allowing the identification of opportunities for growth.
Unfortunately, and due to the nature of some indirect costs, the correct identification of the real contribution margins per customer, that is, not only the classic contribution margin obtained between the difference between the selling price and the cost of goods sold, but also considering other relevant costs necessary to serve customers, is a challenge that many companies are reluctant to face, disregarding the potential that that identification can provide in terms of a more effective segmentation of their customers.
This article aims to present a real example of allocation of such indirect costs, using ABC Costing as a basic methodology. The case that will be shown refers to a large distribution company that operates in B2B and has three divisions according to the nature of the products it sells. Each of them has a commercial area responsible for the sales effort and the technical support required in post-sales activities. Due to space limitations, this article will present the work carried out in the smallest of the divisions, considering the criterion of number of clients; but the methodology applied in the three divisions was the same.
The problem
It was identified in the company in question that there was no evaluation criterion based on real profitability for each of its customers, using only the gross contribution margin to justify their importance. In this way, indirect costs such as, for example, allocating the time of sales consultants to each client, were not considered.
The difficulty in identifying such costs caused uncoordinated efforts to be directed, preventing focus on the most important customers, that is, those in which investing more time would mean obtaining greater returns. Serving all customers equally, without considering the effort required to make the sale and the subsequent after-sales requirements, implied an imbalance or, in more serious cases, in which a lot of effort was directed at low value customers or even those that generated losses for the company in terms of real profitability, despite having a positive contribution margin.
Activity Costing
Activity-Based Costing (known as ABC costing, for Activity Based Costing) is a costing methodology for products, services, customers, channels and other entities that is based on identifying the relevant activities that the company carries out, assigning their respective costs and allocation according to the demand that each product, service, customer or channel exerts on the activity. The main objective of this costing model is to allow a better allocation of indirect costs which, by nature, have little traceability and are normally allocated using arbitrary apportionments.
The main key to a correct allocation of indirect costs within the ABC system, and considering that most companies have them correctly mapped, but face difficulties in allocation, is the identification of the cost driver of the activity, or that is, the variable that determines the demand for work on the activity. As an example, we can mention that the “technical support” activity would have as its cost driver the number of visits made to each customer, allowing, in this way, the total cost of the “technical support” activity to be allocated to each of the customers according to the number of visits made to each one.
Indirect costs at the company in question, previously apportioned by the volume sold, had their respective cost drivers identified, thus allowing a better allocation. They will be presented in the next section of the article and were the result of an internal consensus conducted through interviews with the main leaders in the commercial, financial and logistics areas.
Work methodology
Having as a primary data base the information extracted from the ERP system used by the company already at the contribution margin level, and starting from the premise that the verification of such preliminary result has high reliability, since basically it is a matter of a subtraction of the revenue generated by the respective customer minus the cost of products sold to him, such numbers constituted the starting point of the suggested methodology. Table 1 presents the contribution margins of each of the 21 customers in the division chosen to illustrate the application of the methodology.
Table 1 – Starting point of the work: contribution margins per client
Next, four activities or four indirect cost centers considered relevant and whose values were allocated through apportionment were identified:
- Customer Management: the allocation of the cost of the sales team was carried out through apportionment by the volume sold. This criterion did not correctly capture the different efforts to conduct a sale, being easier in some cases and more complex in others. Thus, the correct cost driver for the allocation would be the time dedicated by the sales team to each of the customers, excluding the time spent on prospecting for new ones and on unrelated activities;
- Technical Support: to carry out after-sales activities, the company has a specialized technical team. As a cost driver, the number of technical visits to each customer served as a benchmark for allocation;
- Events: Some of our top customers are gifted event tickets every year. Despite the great ease of allocating the respective cost based on the customer's presence at the events, which even served as a driver, the respective cost was allocated through apportionment among all customers;
- Cost of Capital: due to the fact that all sales are not made in cash but in installments, there is a cost of capital that is used in these sales. Thus, the driver for this cost was the payment term granted to each of the customers.
The total indirect costs over the year in each of the four categories and the “consumption” of each activity by all 21 customers appears in Table 2.
Table 2 - Resource-consuming activities
The next task was then to identify in the database how much each of the 21 customers consumed from each of the four activities and deduct this value from the gross contribution margin of each one. Table 3 completes the calculation work.
Table 3 - Actual Margins for the Profitability Analysis
Discussion of results
The results obtained show that four clients have a negative margin after the correct allocation of activity costs. This result could be quite different if the BRL 753.109,00 were apportioned among customers according to the “sales volume” criterion. Customers who buy more would be “penalized” for attracting more indirect costs. And these customers would not necessarily be among those who most demand visits from technicians or who need more time to pay, two of the activities that most contribute to total indirect costs.
A question that always arises when observing results such as those in Table 3 is: should the company eliminate those with negative margins from its customer base? The answer is “not necessarily”. In many cases, the fact of eliminating customers does not imply that the cost of serving them disappears and, therefore, this cost will have to be shared over a reduced customer base, which may determine that other customers become unprofitable.
At the limit, all clients will be cut off. In addition, new customers or those who are first testing the structure of the supplier company before directing most of their purchases can also mask such an evaluation. One of the four customers identified as having a negative real contribution margin illustrates this fact. Therefore, it is recommended that the results undergo a qualitative evaluation before taking a more drastic decision.
Suggested actions
The newly suggested qualitative analysis can be structured according to the following set of steps:
- 1st – Reassess: consists of trying to understand why there are customers with a negative real contribution. Most likely, the negative margins are motivated by an imbalance of efforts on the part of the supplier company. In the example in question, this was noticed for customers 7 and 14. It was identified that the segment to which they belonged has a very high price orientation, not consistent with the volumes consumed. In this way, and because this is a very evident characteristic, the entire segment in question is no longer served by the analyzed company, since its positioning in the market, with premium prices, did not favor its participation. The reassessment also includes a review of the cost-generating activities themselves, observing what is real customer demand and what may be the company's service initiatives, but not necessarily demanded by customers. An example of this is the “Events” activity. Although in the case studied it did not “penalize” any customer, it would be important to verify whether the initiative to invite customers comes from the company itself or whether attendance at events promoted by the company is a requirement of certain customers. Now, if to please some customers the company invites them to certain events, it cannot then allocate this cost to that customer's account and then conclude that it is not profitable.
- 2nd – Educate: on many occasions, customers have the need to resort to valuable company resources, such as the sales team or technical support, because they do not have the necessary information to solve a problem. In this way, specific training on the use of the product and services or directing to other forms of service, such as the internet or a specific telephone center, can guarantee an increase in the real contribution margin due to the lower use of the structure by the customer. This was the case with customer 3, who had support requirements that were disproportionate to the volume they purchased.
3rd – Renegotiate: the renegotiation of commercial conditions, both price and payment term, characterizes one of the most effective actions for the repositioning of the respective real contribution margin. In addition, specific billing clauses for required extra activities allow the correct allocation of the extra cost of serving the customer that demands them, thereby preventing such costs from being subsidized by all customers. This was almost the case for client 19. His small final margin was mainly due to the payment period offered.
4th – Transfer: if the attempts made in the previous steps are not successful or if the company itself shows disinterest in continuing the relationship, the customer can be transferred to the service through other distribution channels, such as, for example, distributors. At this stage, it is necessary to persuade the customer to use a service level that is often of lower performance, but that is compatible with the present value that it brings to the company. In the case of Client 1, its service was migrated to a distributor, given the impossibility of renegotiating its commercial conditions.
5th – Close: it is the last step, and only after all the others have not been successful. It consists of the decision to end the relationship with the customer. An important care that must be taken is the legal protection that each and every consumer has and that guarantees their right to be served, that is, the company is not allowed to deny the service.
Finally, it is important to mention that the actions based on the profitability analysis should not be restricted to customers identified as unprofitable. Those that have a positive real contribution margin are also an important source of learning and opportunities, and should be carefully analyzed. Through a more detailed study of which customers have a new positive contribution margin, it may be possible to identify common characteristics among them or even segments, which can motivate a greater focus of sales teams on such specific sectors and which are not well currently served by the company.
Final considerations
Faced with the current shortage of time, increased competition and the need to do more with less, managing the customer portfolio, measuring their respective real contribution margins and correctly allocating their indirect costs, is a critical path for the correct targeting of efforts and resources, thus avoiding a probable dispersion.
The present study aimed to demonstrate, through a real case, in addition to the allocation of indirect costs through ABC Costing, a series of decisions that can derive from the active management of the customer portfolio. The idea is not to eliminate the subjectivity of the analysis of sales representatives on the potential or not of certain customers, but rather that this subjectivity be a complement to a more formal and objective analysis, based mainly on the cost of serving each of the customers. .
The application of the methodology used can be carried out by any company that has, in its service, a plurality of customers, regardless of its size, since the difficulty of allocating indirect costs is a common situation that permeates all organizations.
The article was prepared from the monograph of Marcus Cabral, student of the Coppead Logística Specialization Course, class of 2009, supervised by Prof. Kleber Figueiredo
Tel .: (21) 3445-3000
email: marcus.cabral@shell.com
