Outline what you understand by customer profitability analysis and outline the benefits to be achieved for companies undertaking customer profitability analysis

Customer profitability analysis (CPA) focuses on how individual customer or customer groups contribute to profit. It is derived from the Pareto principle that about 20 per cent of customers account for 80 per cent of profit. In the past, management accounting reports concentrated on analysing products and product lines and although this information is essential, increasing attention is now being given to analysing profits by customers. The focus of this analysis is to ensure that the most profitable customers or customer groups receive comparable attention from the organisation.

The process requires the use of an activity based costing system and involves gathering detailed cost and revenue information for each customer or customer group as follows:

a)   Sales details: These would include the price charged to the customer including any details on cash and quantity discounts.

b)   Cost details: These would involve focusing on the resources consumed by different customers. These cost drivers (the activities that create the customer cost) need to be separately identified and a cost driver rate associated with the activity. Examples of cost drivers under CPA would include order costs, sales visits, delivery costs, special delivery costs, credit collection and non-standard product requirements.

Customer profitability analysis is recognised to have two main advantages: 

• By focusing on the most profitable customers and providing an improved or commensurate service, customer relations improve and customer retention increases. Also by identifying the attributes of this group, other similar customers may be attracted to the organisation.
• By having a knowledge of why certain customers or customer groups do not significantly contribute to profit (and may actually reduce profit), management can assess the difficulties and work on solutions that benefit the organisation as well as the customer.