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Profitability analyses (e.g. by customer, product, region)

11 May, 2016 - 11:43

There are many types of analyses that managers prepare in order to gain a deeper insight into the operations of their businesses. One of the most important of these is profitability analyses. Managers, know, intuitively, that some customers are more profitable than others, that they make more gross margins on some products than others, and if the business has more than just local coverage, that some geographical regions are more profitable than others. While it is good to know such things intuitively, it is better to know them for sure. And knowing them for sure requires that systematic analyses be prepared.

According to Wikipedia, “Customer profitability (CP) is the difference between the revenues earned from and the costs associated with the customer relationship in a specified period”.

“Although CP is nothing more than the result of applying the business concept of profit to a customer relationship, measuring the profitability of a firm’s customers or customer groups can often deliver useful business insights.

“Quite often a very small percentage of the firm’s best customers will account for a large portion of firm profit. Although this is a natural consequence of variability in profitability across customers, firms benefit from knowing exactly who the best customers are and how much they contribute to firm profit.

“At the other end of the distribution, firms sometimes find that their worst customers actually cost more to serve than the revenue they deliver. These unprofitable customers actually detract from overall firm profitability. The firm would be better off if they had never acquired these customers in the first place” (Wikpedia 2009e).

“The biggest challenge in measuring customer profitability is the assignment of costs to customers. While it is usually clear what revenue each customer generated, it is often not clear at all what costs the firm incurred serving each customer”. So, accountants try and develop some sort of reasonable method of allocating fixed and variable costs to customers. A typical method is to analyze each cost and try to determine the proportion attributable to each customer. A simple and clear-cut example is a situation where a store has both walk-in and on-line customers. The costs of renting and maintaining the physical store could reasonably be allocated to the customers who purchase goods in person, based on the number of visits or more likely on the amount of sales to each customer. On-line customers could have the costs of developing and maintaining the website allocated to them. With this information in hand, a customer profitability analysis can be prepared. It is usually prepared in descending order by customer profitability, as illustrated in Table 9.5:

Table 9.5 Customer Profitability Analysis

Your Restaurant Supply Company Year to Date 2009

Customer Name

Gross Sales

Allocated Costs


Rose’s Restaurant

USD 12000

USD 7000

USD 5000

Bill’s Bar B Q

USD 10000

USD 5500

USD 4500

Cal’s Coffee Shop

USD 8000

USD 3500

USD 4500

Alice’s Cafe

USD 5000

USD 3000

USD 2000

Paul’s Pizza Hut

USD 4000

USD 3500

USD 500


USD 39000

USD 22500

USD 16500

Assume you are the owner of the restaurant supply company illustrated in the table. What kinds of useful information can you gather from an analysis such as this?

Many companies prepare a similar type of analysis at the gross margin level and skip the step of trying to allocate costs to individual customers. In this case, cost of goods sold is substituted for “allocated costs” in column three of Table 9.5, and column four will show gross margin by customer instead of profitability by customer. For many managers, gross margin by customer gives them the essential information they need without going through the additional step of trying to allocate costs to customers, which is clouded by its inherent inaccuracies.