eBook

Managing
Customer
Profitability -
Should you love
them or leave
them?

Part of the Profitability

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 CUSTOMER PROFITABILITY
MANAGEMENT
The only value a company will ever create is the value that
comes from its customers – current ones and the new
ones acquired in the future. To remain competitive, an
organization must determine how to keep customers
longer, grow them into larger customers, make them more
profitable, and serve them more efficiently, while
acquiring additional profitable customers.

Many companies measure the profitability of their

customers by the sales they generate, or the gross profit
realized from those sales. Such measures can be
misleading which it comes to enhancing a firm’s
profitability.

Customer profitability is defined as net revenue from a

customer, less customer costs (including both product
/service costs and costs to serve), indirect expenses
(commonly referred to as overhead), and taxes. A useful
alternative measure, customer lifetime value (CLV), is
calculated as the present value of the future cash flow
contribution of a customer. In our Customer Profitability:
How to Measure it and Why it Matters eBook, we discussed
why these are preferable metrics and how they should be
measured.

Once a company can measure the profitability of its

customers it can then work to manage its customer efforts
to generate greater profits, which is the subject of this
eBook.

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DISPELLING MISCONCEPTIONS
A common first step after implementing a customer
profitability management (CPM) system is to rank order
customers (or customer groups) from most profitable to
least profitable and then plot the cumulative profit on a
graph, popularly referred to as a whale curve. As
mentioned in our customer profitability measurement
eBook, such graphs typical show about 20% of customers
generate from 150% to 300% of company profits, about
70% of customers are breakeven, and 10% of customers
reduce or destroy from 50% to 200% of company profits.

Another way to look at customer data is to plot customer

profitability against customers’ sales volume, as in the
figure. The point farthest right represents the highest
sales customer. But above that customer are customers
that make fewer purchases but generate higher profits.
And below profitable customers are many customers with
substantially high sales volume that are unprofitable. The
lesson here is that sales volume is not a proxy for, or
indicative of, the profitability of a customer.

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Sales Volume Not the Same as Profitability

In a similar way, measuring customer satisfaction and

customer loyalty, frequently used marketing metrics, is
not an effective profit-maximizing strategy without also
measuring and managing customer profitability.

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Another way to gain insight into the profitability of
customers is by plotting them on a graph where one axis
represents gross profit from sales to a customer and the
other the cost to serve that customer (i.e., the
distribution, selling, marketing, and customer service
expenses), as in the following Figure.

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The most unprofitable customers in the bottom right -
hand corner of the figure buy low margin profit
products/services while also being the most difficult to
serve. The most profitable customers, in the upper left
corner, buy high margin items while also being easy to
serve.

All organizations have high- and low-maintenance

customers. Examples of high-maintenance customers
include those frequently shifting delivery schedules,
purchasing special products or services rather than
standard ones. They also frequently call the helpdesk or
return purchases. Low maintenance customers, on the
other hand, buy standard items, never shift schedules,
don’t call the helpdesk, and don’t return goods. If a
customer of each of these two types purchased the same
volume and same product mix at the same price, they
would not be equally profitable as the high-maintenance
customers erode profits by causing much more work and
associated expense.

”Customer is King,” or so the saying goes, but can you

accurately determine a customer’s true profitability and how
they help align your organization to its strategic objectives to
create measurable value? The PACE CPM eBook outlines a
straightforward approach to produce accurate customer
profitability analytics that deliver actionable insights to ensure
that organizations add value even in the most uncertain
economic environments.”

Andrew Laferla, Product Director,

Profitability & Cost Management

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TARGETING CUSTOMER ACQUISTION

The goal of customer profitability management is to
implement an optimal blend of differential levels of
treatment so that over every customer’s lifetime, the
profits earned by the firm are maximized.

Once customer profitability is measured and customers

are ranked according to their profitability, the most
profitable customers should be identified. Given that it is
much less expensive to hold onto an existing customer
than it is to acquire a new one, an organization should
strive to retain these customers. It should also seek to
attract similar customers. Actions that might be pursued
include [i]:

Finding common characteristics or behaviors that

make these customers profitable and leverage those
findings into tangible actions to retain them.

Providing personal attention from salespeople,

relationship managers, or their superiors.

Making price or service concessions to ensure the

company remains competitive for these customers.

Finding out what these customers like about the

company and its products/services and promote those
features to attract new customers with similar profiles;
and

Developing a partnership with these customers by

assigning them a high priority in service or pricing.

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When developing a customer acquisition plan, it is
essential to include consideration of the distinction
between fixed and variable costs and the implications of
this difference on the profitability of newly acquired
customers.

“The PACE eBook on customer profitability management

illustrates how profitability inclusive of “below the line”
product-based costs is an important undertaking to
understand the drivers of many costs and to collaborate with
customers to make mutually beneficial decisions. CPM
solutions provide objective measurement of that which has
historically been difficult to quantify, and in so doing, enable
optimized outcomes.”

Doug Paul,
Manager, PCMS

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ACQUISTION & RETENTION

PITFALLS
Retaining profitable customers increases the firm’s overall
profitability, and many firms focus on acquiring and
retaining profitable customers. Pitfalls that can be
encountered in this approach include:

Looking to get the most out of each customer by

focusing only on the short-term profitability or the
next transaction and not on long-term profitability.
This problem occurs when companies focus on
targeting only those customers who are easy to
acquire and easy to maintain, based on the false
assumption that acquisition costs and retention costs
are the major drivers of customer profitability. This
assumes all customers are equally profitable, but that
is usually not the case.

Focusing on customer acquisition rate and customer

retention rate as the sole metrics of marketing
performance, while ignoring customers’ long-term
value. This may lead to diminishing returns on
marketing and sales efforts. Managers can target
customers who are easy to acquire and easy to
maintain based on the false assumption that
acquisition costs and retention costs are the major
drivers of customer profitability. This approach
assumes each classification of customers is equally
profitable, but that often is not the case. Managers
must look at customers who are most profitable to
acquire and profitable to retain, optimize acquisition

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and retention costs simultaneously, and link such
efforts directly to overall profitability [ii].

Treating acquisition and retention as independent

activities and attempting to maximize both rates.
Customers who are easy to acquire and retain may not
be the most profitable customers. Besides
consideration of these rates, the allocation of
resources should be based on the level of choices
between communication channels to ensure customer
profitability.

“Financial data is associated with customers using the

company’s operational data so customer profitability can be a
systematic and repeatable process. Customer profitability
analysis should be a frequent activity, and implementing a
customer profitability management system enables
management to make timely decisions that improve overall
company profitability.”

Dan O’Toole,
Principal Consultant

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INCREASING CUSTOMER
PROFITABILTIY
Actions that can increase the profitability of customers
include:

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In addition to these revenue management actions,

operational improvement, such as improving and
streamlining customer facing processes, adding self-
service models where possible, should be considered.

“At Alithya, we not only implement profitability management

solutions for our clients utilizing the Oracle SaaS EPM
software, but we have also deployed these solutions internally
to gain insight into the types of industries and service lines to
which our most profitable clients belong, resulting in year-
over-year margin improvements.”

Mike Killeen, SVP,

Technology & Strategy

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MANAGING LOYALTY &

PROFITABILITY
An approach to managing customer profitability is to
segment customers based on their CLV and loyalty and
implement separate strategies for each group.

High profitability-High loyalty customers. These are the

most valuable customers, satisfied with the company’s
products/services and purchasing steadily over time. In
managing these customers, firms should engage in
consistent, yet intermittently spaced, communication,
striving to achieve attitudinal and behavioral loyalty.

High profitability-Low loyalty customers. These

customers stay for only a limited time but generate high
profits. They enjoy finding the best deals and avoid
building a stable relationship with any single provider.
Companies should avoid overinvesting in these customers,
especially after they stop buying.

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Low profitability-High loyalty customers. These
customers offer low profits for a company despite being
long-term customers. In addressing how to handle these
customers, firms should determine whether the problem
is a small “share of wallet (SOW)” (the amount customers
regularly devote to a particular brand rather than to
competing brands in the same product category) or a
small size of wallet. If the size of wallet is small, then strict
cost control measures can reduce loss to the firm. If the
share of wallet is found to be low, specific up-selling and
cross-selling can extract profitability.

Low profitability-low loyalty customers. These

customers have little fit with a company’s products and
services. The key strategy in managing these customers is
to identify them early and refrain from making any
relationship investment as these customers have no
loyalty toward the firm and bring in no profits. The firm’s
aim should be to extract maximum profit from every
transaction with these customers.

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BREAKEVEN &
UNPROFITABLE CUSTOMERS
As discussed earlier, many of a firm’s customers will be
breakeven or unprofitable. It is critical that an attempt be
made to bring such customer to the level of profitability.
As a first step the reason for the lack of profitability
should be identified. It may be due to one or more of the
following:

• Low sales volume

• Low selling prices

• High product costs

• High costs to serve

Once the reason has been identified, appropriate actions

can be implemented. In terms of the framework in PACE’s
eBook on revenue management, these may include:

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Additionally, companies can work to improve their

operational efficiencies/effectiveness and/or implement
more effective cost management to reduce the cost of
products/services and the cost to serve customers. The
former of these can be an issue that affects all customers
as when a product or service does not live up to customer
expectations, it is likely to consume additional company
resources and can also result in the gradual loss of
profitable customers.

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DROPPING MONEY-LOSING
CUSTOMERS
After having consider the above actions and implementing
those considered appropriate, a company may find some
of its customers are still unprofitable and consider “firing”
them. Rather than immediately proceed with the firing,
the company should conduct a special analysis to
determine whether firing these customers would actually
increase profits.

It is important to recognize that often not all costs

assigned to a customer are avoidable and would not be
eliminated if money-losing customers were fired. If little
or none of the fixed costs allocated to a “fired” customer
are eliminated, customer deletion may in fact worsen the
company’s overall profits as the customer’s contribution
margin is eliminated but assigned fixed costs and vacated
capacity are not eliminated. If the company cannot
profitably utilize the unused capacity vacated or eliminate
the unused capacity and its costs, it may be more
profitable, at least in the short run, to retain unprofitable
customers.

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CPM AND THE PA FRAMEWORK

CPM should be integrated in every part of the Profitability
Analytics (PA) Framework, which calls for a holistic
approach to managing an organization’s
markets/revenues, operations/costs, and
resources/investments.

In the strategy formulation stage, companies need to

identify their key markets, products/services, and pricing
strategies, how they will organize their operations to meet
the demands of their customers, and the resources
needed. Building causal models in the strategy validation
stage will help ensure the validity of the strategy and its
successful implementation. Finally, in the strategy
execution stage, an organization’s causal models can be
used to monitor execution of the strategy and to tailor its
relationship with individual customers or groups of
customers.
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NEXT STEPS
Customer profitability management is one of the key
issues organizations face, yet most fail to do an adequate
job in this area.

This eBook builds on our earlier eBook describing how to

measure customer profitability. Now that you know the
basics of how to manage customer profitability, it’s time
to get started! In a future eBook we will cover how to
design CPM systems.

[i] Adapted from N. Ellis and D. Hill, “Customer Profitability

Management”, IMA, 2010.
[ii] See V. Kumar and B. Rajan, “Profitable Customer Management:
Measuring and Maximizing Customer Lifetime Value”, Management
Accounting Quarterly, Vol. 10, No. 3, Spring 2009, pp. 1-18.
[iii] Adapted from W. Reinartz and V. Kumar, “The Mismanagement of
Customer Loyalty,” Harvard Business Review, July 2002.

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