Ever wonder where you are making money or (gulp) losing money? Any business can benefit from understanding product or customer profitability. If you are a:
- Contractor - are you making money on residential or commercial contracts?
- Cardiologist or radiologist - are diagnostic services or interventional services more lucrative?
- Winery - is the 750ml bottle of house wine or the Reserve 1.5L magnum more profitable?
There is huge value to understanding your product and/or customer profitability. This information can help you set your strategic direction as well as develop new products, marketing campaigns, loyalty programs, incentive plans, and cost reduction initiatives. Imagine boosting by 10% your lowest margin products or customers - what a difference that would make to your bottom line!
What is Product (or Customer) Profitability?
Identifying the revenue for each product or customer is fairly straightforward. Most accounting systems are set up to book revenue by product category, often down the SKU. You probably even have revenue by customer - if not in your accounting system, then in your CRM software.
However, gaining a clear understanding of the costs can be more challenging. What are all the costs that your organization incurs to produce, sell and distribute each product or to serve each customer?
If your books are set up with precise and accurate Cost of Goods Sold, that will get you part of the way there. But what about the time and effort spent selling the product, servicing the customer, managing the relationship, billing and collecting? What about supplies, inventory costs, and the use of capital equipment?
In order to determine true product or customer profitability, these costs need to be assigned to a particular product or customer. Once this work is done, you will be able to determine where you are (or aren't) making money.
You have done the analysis and figured out which products and/or customers are the most profitable. Don't be surprised if 20% of your products (or customers) make up 80% of your profits - that is not unusual. What do you do with this information?
- Cater to your best customers! They are after all putting food on your table. Do whatever it takes to build loyalty. Give your customers incentives to spread the word about your business. Deepen the relationship.
- Intensify marketing efforts. Promote the heck out of your best products and sell more.
- Find the commonalities. Figure out the similarities of your most profitable products and/or customers. Are all your highest margin products "green"? Are all your best customers tech-savvy? Whatever it is, find more products or customers that exhibit these same qualities.
Making Less (or Losing) Money
What about the other 80% of your business? How do you handle those products and customers where you are working hard and making less - or maybe even losing - money? Here are some possibilities:
- Fire those pesky customers! We know this may feel really good, but make sure they don't have other intrinsic value. Is this person a champion for your business or a good referral source? Do you like working with them? If not, go ahead and make the split. However, first consider finding them an alternative provider for your services. It is always important to keep the goodwill.
- Transform unprofitable customers into profitable customers: Determine why you are losing money on these customers and do what it takes to bridge the profitability gap: cross-sell, up-sell, shorten the selling cycle, transfer management of the account to a lower paid employee.
- Discontinue product lines. Some product lines you can do without and others you just have to have. Consider a coffee shop that loses 5¢ on every muffin they sell. Keep the muffin - customers want it with their (very profitable) coffee.
- Get costs out of the system. If this is a product you want to continue selling, figure out ways to get costs out of the system. This might entail sourcing from a less expensive supplier or more fully utilizing your capital equipment.
Understanding product and customer profitability can give you tremendous insights into your business. It can provide the roadmap so each product or service you provide meets your profit threshold.
Point Your Business Where it Needs to Go!
©2013, Turning Point Financial, LLC