Understanding customer profitability

Last updated on 
July 30, 2020

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Customer-centric business is all about understanding the entire value exchange between you and your customers – and that extends to profitability. Understanding customer profitability helps you identify how you can improve your service offerings and ultimately improve your customer relationships.

And yet only 45% of companies worldwide actually measure it. This is perhaps because it’s quite a tricky metric to pin down; it can vary wildly, depending on different profit attribution models and assignment of costs to customers.

But that doesn’t make it unknowable. With a good appreciation of a few main areas, any business can keep a good grasp of customer profitability.

Why customer profitability matters

Not all customers are created equal. In fact, in most businesses, 20% of customers create 200-300% of all annual profit – while the remaining 80% eat into it by 100-200%. But customer profitability isn’t purely about showing which customer relationships are better than others on paper. It represents a huge advantage for organisational performance and self-knowledge more generally.

Understanding customer profitability lets you:

  • Accurately measure the true cost of servicing customers
  • Surface operational inefficiencies
  • See where you are over or undercharge for your work
  • Identify ways to serve customers better and improve their experience
  • Pinpoint the target customer group you want to attract, retain and grow
  • Identify customers you want to hang on to, even if at a greater cost
  • Make more informed decisions about developing your customer portfolio

Measuring customer profitability

In essence, the customer profitability metric just applies the basic formula for profit to your client relationships:

Profit = Revenue – Expenses

It’s the difference between the revenue a customer earns you and the costs they impose during a given period. So at its crudest:

Customer profitability= earned revenue – customer costs

Looking purely at the numbers, a profitable customer is one whose revenue stream exceeds the costs of onboarding, servicing and keeping them.

What makes customers unprofitable?

There are a range of customer costs involved in your services, which is part of the reason why quantifying customer profitability is so difficult. Tracking all your project work is a great way to make all the of the tasks that go into serving your customers visible. A few of the common costs to keep your eye on include:

  • Communication – everything from daily customer calls and emails, to preparing presentations, attending events, delivering pitches and offsite travel.
  • Revisions – efficient workflows involve very little deviation from a standard model of delivery. Think extra client demands, endless rounds of alterations, frequent changes in direction and a desire for creative control.
  • Discounts – you may have negotiated prices to secure a client, but this can become unprofitable if the relationship turns out to be resource intensive.
  • Custom builds – whether you have to build a new integration or offer tailored services, non-standard work and special delivery requirements can quickly make lucrative clients become unprofitable.

Only once you’ve studied these costs can you work out what you need to change. And that doesn’t necessarily mean writing off a customer – often unprofitability is the result of pricing errors, because companies lack accurate records of time or adopt a one-size-fits-all approach to their services.

How to track customer costs

As the saying goes, what gets measured gets managed. There are a ton of different methods you can use to measure customer profitability, which balance historic Activity-based costs (ABC) with predictive customer lifetime value (CLV). But unless the customer information you are feeding into your calculations is accurate, the usefulness of your results is highly questionable.  

Tracking direct and indirect customer costs is notoriously difficult, but understanding how you spend your time across your customers each day is a great place to start. Automatic time trackers like Timely offer this by giving you full visibility over everything you work on for a customer. They track all the work you do on desktop and mobile and use AI to assign different activities to correct client.

timely-automatic-time-tracking@2x

Intelligent tags help you split out all the different work that goes into a client, and with the help of project budgets, you can clearly identify billable from non-billable work. Since everything is tracked automatically, no detail slips through the cracks – unlike manual recording, you can be confident that you have a fully accurate record of all your business activity for a customer.

distractions-in-Timely@2x

👉 Get an automatic record of all billable and non-billable work

Keeping customer profitability in context

You can’t use metrics alone to properly judge the profitability of your customers. Qualitative information is only one side of the picture, and your profitability scores should be treated as methods, rather than ends in themselves. It may be that an “unprofitable” client on paper yields other benefits which make them profitable in other ways. These can include:

  • The value of a customer’s work for your company portfolio – excessive client demands, special requests and endless iterations are worth it where the work produced is unique, innovative and high-quality. It helps you win the attention of new leads and cement your reputation.
  • Access to a market of strategic importance – don’t write off the value of networking, ever. A good reference from an “unprofitable” customer and access to companies they work closely with can be invaluable for growing your portfolio.
  • Securing higher margin work from new clients – while initial work for new clients can be low-profit, as they scope out the value of your services and relationship, they are likely to buy more from you in time – including more interesting or impressive work.

Remember, good customer relationships require effort from both sides. Truly customer-centric business are sensitive to the needs of different customers, recognizing and trying to accommodate their individual needs as much as possible. It’s about recognizing potential and addressing your own inflexibilities – even if a customer is unprofitable now, they may become invaluable in future.

⚡️ See how you actually spend time across clients

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