Wednesday, August 6. 2008Why Don’t Companies Measure Customer Profitability?Trackbacks
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Hi Gary,
I recently talked with Jerry Boerner, AT&T Mobility’s executive director of management reporting, and they do a very good job of iPhone customer profitability. There are some more details in my blog entry: http://businessfoundation.typepad.com/bf_blog/2008/05/iphone-customer.html While their cost-to-serve model isn't perfect (but they do include indirect cost allocations, etc.), they continue to get more and more precise by bringing in more and more (cost) data sources. Best, -Ron Gary's comments are right on the mark!
Any company that has superior information about the cost to sell a specific product to a specific customer in a specific situation will have a competitive advantage. When a "smart" company and a "dumb" company compete against each other, the smart company will win the easy, high-volume "gravy" jobs and the dumb company will win the difficult, low-volume "dog" jobs. The smart company will have a growth spiral and the dumb company will have a death spiral. In the end, the company with the best cost information wins. I am not sure why they don't capture the information they need but I think part of the problem is a lack of decision-centricity. If they started with the decision in mind and thought cogently about that decision it would become obvious that they needed to know the real profitability of a customer. Sadly too many companies start with the data they have and see what they can figure out that might help someone make a decision instead of starting with the decision they want to improve and figuring out what would help.
JT Hi Gary,
As you know, I focus on Customer Intelligence. For me, customer profitability is one of the key pillars (along with behavior and risk) of a complete CI strategy. For those that are new to the topic of CI, you can get more under www.CIAgenda.com from the white paper. From my work with clients around the world across virtually every industry, I can regretably only confirm what you are saying. Very few organizations measure true customer profitability to any great extent - and even fewer use the insights they have gained. Now all of them SAY they measure customer profitability, but in general they are looking at either customer revenue, customer costing (thanks mostly to your ABC work, Gary, I would guess) or customer margin. Not exactly what we all think of as customer profitability. Why? I think there are a number of reasons and you may be surprised to hear my opinion that none of them have to do with lack of understanding, data or technology infrastructure. First and foremost is still the fundamental belief in the superiority of an organization's own products and services. This leads to every type of measurement - including customer costing - that will give insight into the selling of more products or service. Some would call it an inside out view, but I think it is rather more of an ur-human Maslowian-like core business need. And no one can really fault it. The most successful companies have been using this orientation extremely successfully for years. That brings me to the second reason: there is no pain for not using customer profitability. What John says in his post above is correct - but the advantages of using customer profitability in a complete Customer Intelligence strategy regretably only get really going when the competition is really tough, and you have used up all the "new product" ways of getting an edge. This WILL change in the coming years as competition continues to heat up, and the differentiators gained by measuring and using customer profitability will add to the bottom line. The third reason is possibly distrust. Let's face it, there are a small number of "authorities" on Customer Profitability that through their works, books and publishings have made it incredibly complex and difficult to understand let along achieve (you and the other bloggers here are obvoiusly exempt from this comment!). My experience with a number of major organizations that ARE using customer profitability to provide them an edge always points to the same best practice: start focused and small. Granted, a complete understanding of customer profitability for all customers in all forms for all parts of the organization would be nirvana... and is definately a daunting task. But if you FOCUS (as AT&T Mbility is doing with its Iphone customers - not ALL of their customers for ALL of their products) is the way to go. Start focused on a particular issue (most successfuly with a particular subsegment of your total customer potential), generate a Customer Intelligence Agenda around for THAT issue, and insure that Customer Profitability plays a key roll. Ensure that you can EXECUTE on that knowledge, and that it can be MEASURED so that a clear link is made to revenue growth (not cost savings - that will never be enough). Then promote that success internally to gain the trust and acceptance to expand into new areas. It is definately what seems to work. my two cents worth! cheers, phil Each organization collects different type of customer related information. Some organization:
A) don't have a financial reporting system that shows which customers are unprofitable B) are afraid unprofitable customers will be fired and sales will have to find new customers C) are not sure what they can do to make unprofitable customers more profitable so why bother with a customer profitability calculation. D) have not considered impact of unprofitable customers on total profitability Organizations need to ask themselves which customers order at last minute, constantly change their orders, want special invoicing or shipping, want special modifications to a standard service or product. Then they need to calculate profitability for some of these customers. Finally they need to communicate with these customers on how to make their relationship win-win. Gary's thoughts and thought provoking questions are spot on.
Having completed several strategic balanced scorecard projects, clients will also pay close attention to their customer segmentation and the attributes of each's value proposition. This segmentation then enables the company to orient the right supporting processes for each. Example, segment 1 values speed or time to market, the processes may be automoted. This analysis leads to a discussion on customer profitability where we have assisted companies to conduct "point in time" profitability studies. But rarely do companies invest in the infrastructure to truly capture, track and decision on a routine basis. It would require ABC/ABM capabilities, software etc. You can review articles about this and related performance topics on my website. Hi Gary,
I'd like to offer a quick thought from the ivory tower. Accounting professors do an excellent job teaching students the compliance-oriented languages, but we come up short when it comes to teaching acounting students the languages of internal business management. The educational process teaches students to see the world through a GAAP-based absorption costing lense. This reality certainly does not help accountants to think creatively and productively about how to meaure customer profitability. I agree with Gary, it is an interesting conundrum and, as practitioners, one we should solve together..
In no particular order, the following possible explanations come to mind: 1. Bad breath from the original survey-based technique which was so labor intensive and not definable, repeatable and predictable. The newer drive-based techniques have to overcome this. 2. From the supply-side, the CFOs of the world and their trade associations haven't, collectively, embraced the driver-based "next generation" techniques. 3. From the demand side, Gary's SAMA example notwithstanding, sales and marketing organizations like ANA and AMA haven't taken up the cause. Similarly, neither have CEO organizations like the Conference Board. 4. Most importantly, where are all the driver-based success stories? Answer is that the companies who have exploited the driver-based techniques most successfully view their work as a competitive advantage and won't publicize their successes. 5. PS One application of the driver-based techniques that is getting some focus is M&A/private equity. Quoting from the Acorn web site:" "Mr. Anderson is currently involved with helping Acorn further penetrate the private equity space." Gary is addressing the most relevant issues in today's marketplace in this article. Firms have to be aware of the necessity to track not only the marketing and servicing costs but also on how much to spend on each customer to retain them as profitable customers.
I have always enjoyed reading Gary's work. Best V Kumar Author of "Managing Customers for Profit" Gary
Great question! A couple of thoughts: It depends on the industry and the company. In some industries, the below the line costs (the bottom half referred to) are just 10-20% of the total cost structure of the business (a portion of which might be described as "business sustaining"). In these industries, product/service cost and revenues by customers may be enough to understand the profitability of customers. Some business don't know who their customers are. Business selling to consumers could have millions of customers with absolutely no information on the products and servies they purchase. Big box retailers like Wal-Mart are examples. Calculations of customer profitability are difficult and require estimation. Some business only have a handful of customers and may believe they already have a good understanting of the profiability of these customers. Coal mining where the business sells it products to a few utilities, manufacturers of airplanes, and the semi-conductor industry are examples. Hope this helps. John Miller, Arkonas Corp Part of the problem is that for many businesses customer profitability is irrelavent. How's that for a provocative statement! If I'm Wal-Mart or McDonalds the profitability of individual customers is far less important than my margins on categories, products or in-broadly defined markets. The customer view relates far better to "relationship" businesses than "transaction businesses" and too many transaction businesses waste vast time and effort trying to calculate customer profitability and failing or even worse coming up with a number no one can manage given the weight of allocations.
The whole customer profitability movement smacks of management communism! If its a good idea everyone should be doing it a la scorecards, rolling forecasts, activity based costing, etc. etc.. The real point is that all these tools are situational - they work well for some but are not for everyone. OK;assuming one size does not fit all, paraphrasing John and David, should we determine those SIC codes for which customer profitability is relevant and address Gary's question just to them?
There are a lot of good thoughts so far. I think there are two predominant reasons for organizations not making better use of customer profitability information, both rooted in traditional budgeting:
a) Managers are focused on meeting their siloed targets, typically their budgets, as dictated by upper management. Most of the time, manager’s targets do not include customer profitability because customer profitability is inherently a cross-functional measure. Upper management may be unsure of who to hold accountable for customer (or customer group) profitability; therefore, they avoid using this valuable measure. b) Upper management got to their current positions without customer profitability measurement to guide decision making . . . “So why would I need it now? Besides, I’m really busy putting out fires and trying to understand variances to budget so I can hold my managers accountable for their results.” Here are a few additional comments I gathered from our Strategy Execution team at Hitachi Consulting: c) The complexity of getting to a per customer P&L without a robust BI foundation d) Perceived veracity of the data – the whole lacking “one version of the truth” and the lack of agreement about the numbers… i.e. you are not holding me accountable to those numbers, they don’t match my own calculation, does that revenue consider returns/exchanges/discounts, etc. e) Extension of the silo thought in a) Corporate culture views customer measurements as something that only Marketing and Sales use, yet Sales and Marketing doesn’t want to be measured on profitability, because, “We just sell it. We don’t have any control on the cost of delivery.” f) I’d ask: so why not hold manufacturing & purchasing accountable for non-overhead cost variance (volume adjusted cost of materials, service, labor, etc.) and sales & marketing responsible for price variance (sales price relative to planned sales price given market conditions)? If you do so, you have the controllable components of profitability relatively well covered. Gary,
I fully agree with your observation that when an organisation knows its profitability by customer, it can use this information to increase profits and boost shareholder value. However, in my experience many organisation lack the courrage to "dismiss" customers and keep chasing "poor quality deals". A good example of this is that many organisations still spend tons of time (and money) to submit proposals for government tenders where the price criterium is 50% or more of the decision maker. Another good example are online auctions for commodities where price is the main discriminator. Is seems to me that companies just want to be fooled. Jan Smolders Gary,
All of the comments have not only been thoughtful but also, more importantly, representative of a broad cross-section of perspectives. They all have one assumption in common, however; specifically, the current technology. Might the current technology be part of the problem? Not functionally rich enough for broad acceptance? Do clients want something predictive? Something optimized? Something that will allow multi-variate whale curves (e.g., product AND customer)?. John Miller in the 2/4/08 issue of his thoughtful newsletter "ONE EIGHTY" outlooked just such functionality when he described "Optimized Planning and Budgeting" (see http://www.arkonas.com/Resources/Planning%20and%20Budgetinga.pdf). Turns out John was prescient. Just such functionality will be available by the end of the year in a product called Integrated Enterprise Strategy (IES). It takes the last three steps in Kaplan and Norton's Stage 3 (forecast, budgeting and capacity planning; see 1/08 HBR, "Mastering the Management System") and optimizes all three simultaneously. Time will tell whether IES's new functionality stimulates some additional interest in customer and product profitability; Gary,
Right on the mark as always. I look with amazement at how companies and the people that manage them can overlook such potent information/decision tools. Cost to serve, or customer profitability aren't right for everyone, though, as noted by John Miller and David Axson regarding industry and customer characteristics. To drive profit improvement, these companies can measure what drives and consumes costs for them. But in either case, the measurement and action it can drive offer tremendous benefits. Some additional thoughts: In large and mid-sized enterprises, I have often experienced both sales and marketing managers/execs who embrace these measures as something that will help them focus sales efforts in the right place to build business. But they frequently have a lot of skepticism, so there needs to collaboration to get buy in. This group usually has neither the time, skilled financial personnel or access to the data and IT resources needed to pull it off themselves. A champion and "partner" from finance or accounting is needed. Seven or eight years ago, management accountants were being urged to embrace a sea change, to be "value added" by bringing ideas to the table to help drive profitability improvement, rather than just report it. In today's enterprise, I've observed the accounting and finance folks are stretched thin, focused on compliance, process speed (think lean accounting and 2-3 day closes), and low cost (think thin organizations). There seems to be less risk taking today to stretch the thinking of the organization, to position the accountant or financial manager an agent of change and performance driver. Could it be that there is simply an absence of compelling or competitive examples that might drive companies to change their measurement systems so dramatically?
After all, there are lots of far-reaching -- and difficult -- implications for change associated with measuring customer profitability. It implies dramatic organizational change, not just a change of measures. Why change if one's competitors aren't? Classic chicken and egg issue. Another reason: Wall Street (more specifically, the SEC) isn't demanding it. It seems that companies tend to be relatively passive and conservative toward their measurement/accounting approaches in the Post-Sarbox Era. It's perceived as risky to get ahead of the regulators -- even if it represents a potential competitive advantage. So far, few companies are willing to seek competitive advantage in areas that could, possibly, lead to accounting headaches -- or worse. Gary,
since the good old times of Management by Objectives (MBO), the middle managers conflict of interest has not really changed: Customer Profitability has its interesting part on the costs side; costs are budgets, and a budget gives a relative autonomy of decision. If an Activity-based Costing (ABM) system displays clear figures about unprofitable customers there will be no excuse for decisions, optimizing personal aims in conflict with the company’s objectives. In all industries we still find structures, which trigger employees’ unethical behavior of distorting the system or financial figures to achieve the targets, set by their short-term, narrow bottom-line and completely self-entered thinking. The uses of modern IT-based systems and methods like ABM or Performance Management (PM) have proven, that transparency does improve profitability dramatically. A top management’s sponsorship and carefully aligning these initiatives with a cultural change of the organization guarantee the success. |
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