A 5-step customer profitability analysis

If you own a B2B company, here’s a scene you might recognize.

Your salesperson complains to you after talking with a customer for 40 minutes.

“I just got off the phone with the Jones account,” they say. “This guy calls me every day, and I keep telling him, ‘Mr. Jones, it’s on our website. You can look that up.’ But he never listens to me.”

You might wonder how much time and money you are wasting on conversations with customers like these, especially if they are not making many purchases from you.

That’s where a formula called a customer profitability analysis comes in. It helps you determine which customers are costing you or making you money.

“This is all about calculating the true profitability of a customer, assessing what this client is worth to you,” says Ajay Sirsi, Director at the Centre for Customer Centricity at York University’s Schulich School of Business.

Sirsi says some customers will take up more time than others. That time is valuable and may cost you more than the customer is spending.

Sirsi says all that activity may be draining your profits without your realizing it. He particularly sees this in companies that are ramping up in volume. They lose certain customers because they’re not properly allocating their resources and attention to those who pay more.

He offers an example: “A salesperson sees a loyal customer and finds out they are now buying from the competition. Why? Because your salesperson never visited this customer! They didn’t have time. They were so busy focusing on all these other customers like Mr. Jones.”

He says the problem lies in businesses spending too much time trying to please every customer.

“It’s especially relevant for new and small businesses. When you opened your shop, customer profitability was not on your mind.”

He says you need to recognize when you are trying to be all things to all people—that’s when it’s important to segment customers. Recognize which ones are putting you in the red and which are helping you turn a profit.

Sirsi offers a 5-step process for conducting a customer profitability analysis.

Step 1 – Calculate the true price your customer pays

To determine the real price for each customer, subtract any discounts you have given from the invoice price. The result is the true price your customer pays.

True price example

Step 2 – Calculate the true cost to serve each customer

Figure out what each customer is costing your business.

To do so, examine each customer at a time. Calculate everything you do for them that falls outside the fixed costs of serving a customer. The true cost to serve that customer is the price of all those favours plus the fixed costs.

The true cost to serve a customer

Step 3 – Calculate customer profitability

Next, subtract the true cost to serve the customer from the true price your customer pays. The result shows customer profitability.

Here’s how you would calculate customer profitability:

Step 4 – Identify your A, B and C customers

Once you’ve done all the necessary profitability calculations, you will end up with three main kinds of customers. Some will be profitable. Others will end up on the negative side of the ledger, where the true cost to serve them is higher than the true price you receive from their purchases. 

At this point, you’ll need to identify your A, B and C types of customers by their profitability, neutrality or unprofitability.

Step 5 – Negotiate and educate your B and C customers

Identifying your A, B and C customers helps you know what each one needs.

For the A customers, it’s simple: keep them happy. They are profitable because what they pay is higher than the cost of serving them. That means you can keep giving them the same level of service. And if they ask for more time, you know you have a cushion of profitability.

Sirsi suggests that you approach the B and C customers.

“Step 5 is all about negotiation, where you go to customers like this Mr. Jones and say, ‘We’ve done the analysis. We cannot continue this way.’”

Sirsi says the B and C customers need to know that you can’t make a profit if you do all these things for them. He suggests identifying and naming the free favours before warning customers that they will be charged for this kind of service in the future.

“For example, if they make last-minute changes to engineering drawings,” he says. “It’s a matter of educating customers, because they may not even realize they’re costing you money.”

Sirsi says it’s vital to educate your staff, especially if they have been doing everything to try and please the customer. “You have to instill in your staff that profits are the lifeblood of a business,” he adds.

How to increase the number of profitable customers

Sirsi uses this exercise to manage expectations.

“A customer profitability analysis shows how much time you can put into each customer and how much you can discount,” he says. “This all plays into their expectations. If customers have high-needs expectations, but you have a low-needs capacity, that’s a problem.”

Ultimately, this is an exercise to increase the number of profitable customers. You can eventually turn your Bs and Cs into As by examining your profitability spreadsheet, establishing cut-offs, and negotiating with customers.

Sirsi says that, as a business, you must remember how important it is to look closely at your customers. A customer profitability analysis will help you step back to gain a clearer picture of who is costing you too much: “Many B2B owners have been so busy trying to build their customer base that they’ve been thinking all customers are good customers.”

Next step

Discover how to analyze your business financial information by downloading the free BDC guide, Build a more profitable business.