Using Profitability Analysis

Few businesses today can afford to treat all customers and clients the same, despite their desire to do so. Different treatment for different customer groups is unavoidable. The fundamental issue here is how to group customers so as to benefit both the business and its customers. Typically, the business is favored in the process but this is changing.

Sales and profitability are two of the most popular measures for grouping but profitability is by far the better measure. Often, you will find that some of your largest customers in terms of sales volume may be unprofitable. This identifies a critically important customer segment — large but currently unprofitable customers — that needs a special strategy aimed at retaining them while increasing their profitability.

Profitability is more difficult to determine but can be a powerful segmentation metric if applied properly. Many businesses use current profitability alone because it can be calculated with some precision from available data. A better measure, however, is a combination of current profitability and profit potential. Profit potential estimates can help identify customers who may be small and even unprofitable currently but have the potential to be high profit customers in future.

Once you have classified your customer base by profitability, you can develop different marketing, sales and customer service programs for each customer group. Most businesses today have a variety of such segment-specific programs.

What they rarely have is any systematic way to refine and improve programs aimed at each customer segment. This is where we can help.

While our primary focus is on measuring and analyzing programs, outcomes and situations and helping businesses make these programs more effective, we can provide support at virtually any stage of the process.

The diagram on the next page outlines a process that uses profitability analysis to group customers and increase overall profitability, market share or other segment objective. It has five main steps:

2. Development of segment strategy and programs (marketing, sales, customer service)

While this diagram is for a financial services business, it illustrates the process steps involved in moving from customer, cost and pricing data to program improvement.

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