Customers profitability analysis

Mulhern, F. J. 1999. Customer profitability analysis measurement, concentration, and research directions. Journal of Interactive Marketing, 13(1) 25-40. 

Figure 3.11 Customer profitability analysis a basic model... 

An application of logistics cost analysis that has gained widespread acceptance, particularly in the retail industry, is a technique known as direct product profitability - or more simply DPP . In essence it is somewhat analogous to customer profitability analysis in that it attempts to identify all the costs that attach to a product or an order as it moves through the distribution channel. 

Most importantly, customer profitability analysis enables focal firms to link supply chain efforts to customer value and market opportunity in a way that improves customer relations and revenues in a profitable manner. 

Design data and other process information are obtained during the development stage. This information is used as the basis for carrying out the additional phases of the design project. A complete market analysis is made, and samples of the final product are sent to prospective customers to determine if the product is satisfactory and if there is a reasonable sales potential. Capital-cost estimates for the proposed plant are made. Probable returns on the required investment are determined, and a complete cost-and-profit analysis of the process is developed. 

Companies can define themselves by the type of customer they seek to service. For this purpose, the customer profitability matrix provides four categories. It requires detailed cost analysis and allocation of indirect costs for all customer segments. This encompasses pre-sale costs (location, need for customisation, etc), production costs, distribution costs, and after-sale service costs. The actual prices charged to different customer segments are subsequently assessed, together with the volume consumed over time and its value. The matrix (Figure 2.4) has net price on the vertical axis, and cost on the horizontal, and is divided into four quadrants ... 

The activity-based analysis showed how a combination of the customer s mix of products purchas and ordering habits determined customer profitability. The company concluded that these same factors should be considered when establishing a customer discount. To effect this change, PlumbCo provided each sales representative with a laptop computer and a simple spreadsheet to support the discount decision. This spreadsheet is shown in Figures 36.1,36.2, and 36.3. On the spreadsheet, the boxed and shaded areas are for input of customer data the balance of the spreadsheet calculates automatically. 

This approach becomes particularly powerful when combined with a customer revenue analysis, because even customers with low sales offtake may still be profitable in incremental costs terms if not on an average cost basis. In other words the company would be worse off if those customers were abandoned. 

A number of interesting conclusions can be drawn from this analysis. Comparing high- versus low-price customers, we find, as expected, high-price customers to be more profitable. These customers are also more satisfied with their primary vendor s and less satisfied with other vendors performance than low-price customers. Customers are willing to pay a higher price with increasing differences in their satisfaction... 

For consequence analysis, we have developed a dynamic simulation model of the refinery SC, called Integrated Refinery In-Silico (IRIS) (Pitty et al., 2007). It is implemented in Matlab/Simulink (MathWorks, 1996). Four types of entities are incorporated in the model external SC entities (e.g. suppliers), refinery functional departments (e.g. procurement), refinery units (e.g. crude distillation), and refinery economics. Some of these entities, such as the refinery units, operate continuously while others embody discrete events such as arrival of a VLCC, delivery of products, etc. Both are considered here using a unified discrete-time model. The model explicitly considers the various SC activities such as crude oil supply and transportation, along with intra-refinery SC activities such as procurement planning, scheduling, and operations management. Stochastic variations in transportation, yields, prices, and operational problems are considered. The economics of the refinery SC includes consideration of different crude slates, product prices, operation costs, transportation, etc. The impact of any disruptions or risks such as demand uncertainties on the profit and customer satisfaction level of the refinery can be simulated through IRIS. 

Identify Delivery Requirements One of the key data reqrrirements in analyzing a distribution network is that of the delivery reqrrirements (time order placement to receipt of the shipment). If the reqrrirements are not identifiable, a customer satisfaction gap analysis must be undertaken. The gap analysis is a series of questions directed at internal staff and customers. The purpose is to identify discrepancies between customer perception of satisfaction and satisfaction requirements. At some point, the sales sharply decline because competition exceeds both your delivery and yom cost (assuming equal product quiity). The key is to find the best customer satisfaction that maximizes profits. 

In the most mature companies, revenue management is a subprocess or a piece of cost-to-serve analysis. Cost to serve is defined as a process that calculates the profitability of products, customers, and... 

The benefit of cost-to-serve analysis is twofold identification of the cost elements of a relationship and the visualization of orders that are not profitable. The relative costs per customer can vary greatly as shown in Figure 5.6. 

It is important for firms to project their cash flow. This ensures that they will have funds on hand to pay their bills and their payroll and to invest in new projects. Cash flow is watched carefully by the finance department, because it is possible for a firm to make a profit on paper and still go broke because they do not have the cash needed to pay bills. When a firm invests in a new plant or new equipment, someone estimates the cash flow to calculate how the investment will influence the firm s ability to pay bills and dividends. In the example above the expenses were shown only as fixed or variable and the calculation was not concerned with the time period in which the expenses had to be paid. Likewise, the sales revenue was calculated on a per unit basis, but the sales may come at different time periods and some of the money for the sales may not be collected immediately. Based on historical records and contracts with suppliers and customers, the firm estimates its cash flow over the relevant time period. The cash flow analysis is shown in Table 3.1 for the example above. The cash flow analysis provides new information that the break-even analysis did not provide. It uses the period-by-period forecast to estimate when the firm will receive money and when it will pay out money. For the first seven months of the project the firm will have negative cash flow of 56,000. Then as sales pick up it will alternate positive and negative cash flows. Part of the reason for this is that revenue will be received 30 days after the product is sold, but the expenses to produce the product will be paid the month earlier. 

Number of prototypes If they are cheaper, it may make sense to develop more prototypes. How many and how to best make use of the increased flow of customer preference information are researchable questions (see Dahan and Mendelson, 2001, for an analysis of how the optimal number of prototypes and the expected profit are affected by the cost of building and testing product concepts). 

The manufacturer produces at unit cost c, and the retailer purchases at wholesale price w > c. All sales occur at the same exogenous price r. Random variables Dm and Dr describe first-choice demand in the direct and retailer channels, respectively. A fraction a of customers who encounter a stockout in their preferred channel will subsequently search the other channel before walking away. This dynamic is what induces interdependence between the two channels. The resulting objective functions have newsvendor form (with product substitution) and the two firms simultaneously choose order-up-to levels. The analysis proceeds to identify the equilibrium stocking levels and profits of... 

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