Identifying customer/segment revenue is usually one of the easier pieces of data to capture.
What starts to cloud the picture is the cost base and allocation of indirect costs. Organisations have tended to apply a ‘robust activity-based costing’ process to support customer/segment profitability.
The key challenge has always been that this process can take weeks and in some cases months to provide accurate information. Businesses do not have months to spare to make decisions. This means that there will be continued pressure on the finance team to provide a rigorous process that balances precise accuracy against timeliness and relevance to the business. This is where transactional business systems can make the difference. Actual work delivered for a specific customer is usually recorded in existing business systems. Incorporating this type of data on a weekly or monthly basis helps understand the subtle differences in effort and cost spend for different customers.
Once you start building in risk-based profitability, there is the added challenge of capital, which will allow you to better understand the risk-reward equation and assess the returns on capital, resulting in better capital decisions. For many in the financial services sector, there is, and will continue to be, focus on economic capital, with increased pressure coming from regulators not only to improve reporting down to customer/segment levels, but also to translate this insight into making improved business decisions.
Ensuring customer profitability
Ensure you have buy-in from the business. There’s no point having better information about customer/segment profitability if your stakeholders are not prepared to use or value it. Business buy-in has to occur at the outset, prior to developing a new process or technology solution.
Get the basics right first. You need to earn the right to move beyond the fundamentals. If you are struggling to get your core financial information to stakeholders on time and accurately, it is very unlikely that you will get the next level of information right.
Validate with the business, early and frequently. The profitability model will take some time to mature. Early and frequent validation from the business will help improve the quality of the model and enhance the ownership the business feels with the outputs.
Set a progress plan to better manage information. This is not a sprint − it will take some time to master your information flows and outcomes.
Ensure your management information supports your business and strategic needs.
Understand the key drivers of the business. You don’t need to measure everything; only allocate and measure support costs relevant to customer pricing and customer decisions.
Innovate or perish
This approach to customer profitability represents a real challenge to traditional product group structures and one-dimensional thinking. So why embark on this kind of initiative, particularly given many have tried and failed in the past?
The answer is simple: if you don’t, you will be left behind in a fast-moving environment in which finance is already struggling to stay relevant and add value to the business strategy. CIOs may own the data, but finance owns the information – that may not be the case in the future.
Understanding the true profitability of your customer isn’t always as straightforward as it appears to be. Your top tier clients may not be the most profitable, particularly as they tend to ask for the biggest discounts for products or services. Unless you understand your customer base and the cost to service them you may be making the wrong pricing decisions.
It is critical for the finance team – who are the custodians of the information – to be at the forefront in influencing business strategy, so you can see your customers’ value clearly and look beyond the surface to determine their real profitability.
Profitable customer-centricity
Most organisations maintain that they have a strategic focus on the customer. Some of the most common rhetoric we encounter from businesses of all sizes includes: ‘moving to a customer-centric model’ and ‘customer is king’.
Many organisations, however, are still driven by product-centric structures and rely on their core finance systems – the general ledger (GL) − to support financial decisions. This approach does not necessarily facilitate the multi-dimensional view of financial information which organisations need to truly understand the value of their customers.
Although most CFOs and finance teams will have some form of profitability reporting in place, very few have the capability to provide detailed insight into customer profitability. They generally struggle to provide the relevant insight that supports the strategic direction of the business. So it is absolutely essential for companies to realign their structures and systems around understanding the profitability of their customers.
Broadening your tunnel vision
Customer profitability is by no means a recent phenomenon; organisations have been trying to understand what their customers really contribute to their businesses for the last 20 years. However, in a global market delivering little competitive advantage and an abundance of data, there is a new emphasis on driving operational effectiveness and the ability to make better investment decisions. Part of the issue lies with the inability of the organisations to mine/use this data to provide relevant and useful insights regarding customer profitability and the appropriate channels to facilitate effective business decision-making.
As the business world becomes more complex and more demanding, organisational strategies are being developed to better understand the customer base and the differing channels available.
Finance has traditionally looked at financial performance through a single lens, assessing overall profitability and then drilling down to assess the profitability of its core products or services.
This approach does not necessarily create the ability to understand what customers or customer segments are profitable or otherwise (and we are not talking just about revenue). The questions that are really important to resolve include: what are the optimal service channels to support increased profitability, and what areas should be discontinued?
When organisations change their approach to understanding customer profitability it can come as a surprise that their top clients may not be the most profitable, particularly as they tend to be the customers asking for the biggest discounts for services. Unless you understand your customer and cost to service them you may be making the wrong pricing decisions.
Customer segment profitability is not an exact science and requires a level of subjective analysis, however, it can provide a reliable level of guidance to allow for improved business decision-making. If you understand the drivers of customer/segment/channel profitability the right decisions can be made before the wrong results appear. Even though insight into the actual profitability is important, understanding the underlying drivers is critical. The information becomes key in deciding to transform an unprofitable customer through better channel use, product or service pricing or to exit a relationship.
A granular understanding of financial levers can make a profitable customer even more so. Remember that a bigger customer may not be the most profitable. However, having the right information is only useful if it is timely and accurate; there always needs to be a balance between getting things perfect and providing timely information for decision-making.
Empowering your business through customer profitability modelling
The ultimate aim of customer profitability modelling is to help grow the bottom line. The right approach will empower a business by providing the key information that will facilitate better decisions.
Overcoming challenges to understanding client profitability
Data overload: Many organisations lack understanding of key business drivers because they are overwhelmed by the data they possess.
Complexities with customer identifiers: It is crucial to have succinct customer identifiers when processing financial information. However, it can be difficult when faced with linking parent and subsidiary companies or dealing with acquisitions.
