Companies of all sizes are losing millions of pounds in profit every day. How much are you losing?
How do we lose it? Because revenues from different customers are not equally profitable. Research in America shows that half of all products and customers lose money for suppliers. Do you know which your half is?
The problem is that most businesses don’t know where their costs come from and how much profit they really make on each customer. Because they don’t treat their products and customers as individuals. The reason for this problem is that we take total costs and share them out. But we don’t find out where those costs really come from. Until we do, we can’t take action to get that profit.
So we need a different method of arriving at costs, one that takes account of what creates costs. One tested method is Activity Based Costing (ABC), initially developed by Professor Robert Kaplan of Harvard Business School. It doesn’t ask what share of overall cost should we allocate to a product or service but rather what cost does that work create?
Traditionally we share out our costs such as staff, premises, utilities, invoicing, customer service and all the range of business activities by some arbitrary measure such as share of revenue. Is this accurate? No. Instead of sharing total costs out, we should work them out.
For example, your parcel carrier might charge by weight. Simple, yet that doesn't reflect the true cost of carriage so much as factors like size or the number of items being collected from the customer. A kilogram difference in weight makes little difference to a man picking them up one at a time - and now that most central sorting is done by conveyor it makes no difference at all.
So how do you find your unprofitable products and customers?
1. find out your cost drivers
how much it really costs to make our product or service
We start by analysing the production process and the sales process to see what actually happens and thus what costs you incur. In one product, we uncovered an actual cost ten per cent higher than the accounts showed.
how much it costs us to sell part of what we have made
Customers don't automatically make you money. They eat your profit. Customers are a business activity and like all business activities there is a cost. It costs money to get that revenue – but does it cost too much?
Find out what it costs you each time you sell a part of what you do.
Customers might spend a lot with you, but is it in a few big blocks or lots of little jobs? Each transaction has a pretty similar overhead: using a banking example, it costs just as much to process a cheque for £100 as for £1,000,000. Guess how they would rather get a million pounds?
Sometimes the cost of the transaction dwarfs the cost of production. Recently we discovered that the cost of sale plunged a service from a small apparent profit into one that didn’t cover the cost of even selling it. Yet nobody knew.
how much it costs us to keep a customer
It costs over five times as much to gain a new customer as keep one. CRM vendors tell you that customer satisfaction drives up loyalty. Manchester Business School found that satisfied customers are 65% loyal but the very satisfied are 95% loyal.
So satisfaction seems a good idea. How much does this extra satisfaction cost you? Too much? American automobile manufacturers typically have satisfaction rates of close to 90%, but repurchase rates of 30% to 40%. And some customers of big software companies are very dissatisfied - but very loyal as they can’t move away from their commitment.
Satisfaction and loyalty don’t automatically mean profit.
2. Discover your profitable customers
Create a grid of customers and products, noting revenues against the real costs for each product a customer buys. See whether we are making a profit from them. It can be surprising: one international parcel company discovered that a single customer enquiry over the phone consumed the entire profit from the next six parcels that it carried for the customer.
Big customers aren’t always your best customers. Customers can be big customers because you spend lots of time with them, underprice your products or just bend over backwards: all these are costing you money, your money.
3. Take action to capture all your profit
This is where you see the benefit. Knowing which products and which customers make us money means that we can make decisions. Analysis alone doesn’t give us the answers, but the facts to base decisions on.
There are no standard answers, but only answers that match your business goals. We will help you to make decisions like:
should we stop a service line?
can we change the process?
what will the future profit from that customer be?
should we provide different methods of customer service for different customers?
do we need to charge this customer more?
You’ve worked hard to make your business a success. Surely you deserve that your business works hard for you by giving you all the profit that you have made. So work for your wallet, not to subsidise your customers.
John is Director of Thinking at Profit Per Minute Limited. If you’d like to discuss the article, he can be contacted by phone on 01865 771329 or by email at email@example.com