Customer profitability analysis - ICAEW

GOOD PRACTICE GUIDELINE No 37

Customer profitability

analysis

MARCH 2002

ISBN 1 85355 84152 106 X

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CUSTOMER PROFITABILITY ANALYSIS

GOOD PRACTICE GUIDELINE MARCH 2002 FACULTY OF FINANCE AND MANAGEMENT

Preface

Research indicates that Facultymembers expect regularinformation, ideas and guidance.The concept of Good PracticeGuidelines has therefore beenadopted.

As chartered accountants oftenhave less time available for readingthan they would wish, thesedocuments are succinct and thewriters will direct the reader toother, and often fuller, expositionson the subject.

The guidelines will give a generaloverview and an analysis of thecritical features of the subject,aiming to be practical. Some willsummarise suggested goodpractice and others will bediscussions on current conditions.Authors are chosen on a ‘mostappropriate for the subject’ basis.The guidelines are the personalviews of the authors and notnecessarily those of their firms or ofthe Faculty.

Some guidelines will have a limitedlife and will be updated in duecourse. The nature of somesubjects will preclude the guidelinesfrom being definitive ormandatory. Being general innature, the points made in theguidelines may or may not berelevant to specific circumstances.

The Faculty committee intendsthat the guidelines will act as anaide-memoire for members,provide new ideas, and encouragegood practice, but cannot acceptresponsibility for their accuracy orcompleteness. Responses frommembers will be a very importantpart of the successful developmentof the guideline tool.

Comments, please, to Chris Jacksonon 020 7920 8486 or to the website (www.icaew.co.uk/members).

Introduction 3

Analysing customer profitability 13

Improving customer profitability 26

Conclusion 30

Endnotes 31

Bibliography 32

CONTENTS

Customer profitabilityanalysis

Strategic cost management and activity-based costing havecaused companies to look more closely at the drivers of theircosts. This Good Practice Guideline provides examples ofboth the analysis of customer costs through activity-basedcosting and the development of long-term customer relation-ships for increased revenues and profits through the mea-surement of customer value.

This material was originally published as a ManagementAccounting Guideline, produced by The Society of ManagementAccountants of Canada, and is reproduced here (with minoramendments) with their kind permission (for more informa-tion about the SMAC – see page 34). It was prepared with theassistance of Marc Epstein, Research Professor of Management,Jesse H. Jones Graduate School of Management, RiceUniversity.

ABOUT THIS GUIDELINE

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GOOD PRACTICE GUIDELINE MARCH 2002FACULTY OF FINANCE AND MANAGEMENT

Introduction

In Charlotte, North Carolina, the customerservice centre of First Union Corporation, thesixth largest bank in the US, handles 45 mil-lion calls per year. The centre’s computer sys-tem, ‘Einstein’, determines the ranking of acustomer – profitable or unprofitable – in 15seconds. Customers are assessed with respectto minimum balance, account activity,branch visits, and other variables. At the ser-vice desk, the computer screen displays acolour – red, green, or yellow – to signify thecustomer’s profitability rating. Thus, when acustomer requests a lower credit card interestrate or a waiver of account service fees, theservice representative is able to respondquickly according to the customers’ rating.

A company can outperform rivals only if itcan establish a difference that it can pre-serve. It must deliver greater value to cus-tomers or create comparable value at a lowercost, or do both.

Michael E. Porter. 1996. ‘What is strategy?’ Harvard Business

Review (November-December).

First Union recognises that not all customersare the same. Though customer satisfaction isimportant, the goal is to increase customerand corporate profitability. Customer prof-itability analysis is evolving as a basis fordetermining the level of service that cus-tomers receive and the level of their fees.First Union estimates that its ‘Einstein’ sys-tem will add at least $100 million to itsannual revenue.

About half of that will come from extra feesand other revenue from unprofitable cus-tomers, while the rest will flow from pamper-ing preferred customers who might otherwiseleave the bank. First Union is not alone inthis effort; an increasing number of compa-nies employ the same procedures to deter-mine profitable and unprofitable customersand manage customer relationships toimprove corporate profits.

The example above is one of many thatdemonstrate the increased corporate focus oncustomers and their profitability. This guide-

line presents a discussion of the state of theart and of best practices in determining cus-tomer profitability with respect to:

■ understanding and analysing customerprofitability;

■ maintaining and increasing customer prof-itability; and

■ turning unprofitable customers into prof-itable ones.

The guideline does not present a detailedexamination of an all-inclusive analyticaltool for determining customer profitability. Itdoes, however, provide the tools that permitthe analysis of customer profitability and theimplementation of programs to improvethese profits.

Over the last 10 years, strategic cost manage-ment and activity-based costing (ABC) havecreated a framework for companies to exam-ine more closely the drivers (or causes) oftheir costs in order to improve managementdecisions and corporate profitability.Companies initially focused on product prof-itability are now using ABC and other modelsto examine further the profitability of distrib-ution channels and customers.

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Simultaneously, many companies are explor-ing the drivers of profit and success throughthe use of the balanced scorecard. Whichevermodel is used initially, determining customerprofitability requires a clearer understandingof the causes of the revenues and the costs.This guideline provides details of companyexperiences in examining the causal relation-ships between the drivers of customer satis-faction and customer revenues as well as inmeasuring the profitability and costs of ser-vicing existing customers. Comprehensivesystems that identify, measure, analyse andmanage customer profitability and its driversare only now being developed (Epstein,Kumar, and Westbrook 1999).

Expanding global competition is one reasonbehind the increased concern for customerprofitability. Companies worldwide are beingpressured to become more customer focusedand to increase shareholder value. Customerprofitability analysis is a useful tool in bothareas.

Increasing customer focusMany companies are convinced that improv-ing corporate profitability requires more cus-tomer contact and closer customer relation-ships. Further, many marketing professionalshave directed recent attention to increasingcustomer satisfaction, primarily examiningthe links between overall satisfaction and

revenues. Meanwhile, accountants have tra-ditionally focused on cost reduction.Customer profitability analysis attempts tobring together marketing and accountingprofessionals to analyse, manage, andimprove customer profitability.

Companies are attempting to understand bet-ter and to satisfy present and future customerdemands. However, the goal is to increasecustomer satisfaction profitably. The analysispresented here, relying on ABC and other

tools, can direct managerial attention toareas of improvement that can lead to greatercustomer and corporate profits. An ABC sys-tem is not the only means to measure cus-tomer profitability, but merely one of severaltools that can be used.1

Since ABC provides a better understanding ofthe profitability of products and services,companies have started to use the sameapproach to understand the profitability ofcustomers. Following an ABC analysis, com-panies can examine the customer profitabili-ty information and determine how to man-age customer relationships in order toincrease customer satisfaction and the prof-itability of both individual customers andcustomer segments. The ABC analysis oftenprovides information leading to suchimproved relationships that the profitabilityof both the company and its customers isincreased.

Companies have been using improved infor-mation technology and large databases tohelp refine marketing efforts. Marketing toolsand IT systems now permit companies to tar-get individual customers and customergroups with pinpoint accuracy and to deter-mine whether or not a customer spendsenough to warrant the marketing effort. AtFederal Express, for example, customers whospend a lot of money but demand little cus-tomer service and marketing investment aretreated differently than those who spend justas much but cost more to maintain. In addi-tion, the company no longer markets aggres-sively to those customers who spend littleand show few signs of spending more in thefuture. This change in strategy has substan-tially reduced costs.

Fed Ex also analysed the profitability of the30 large customers that generated about 10%of the total sales volume. The companyfound that certain customers, including somethat required a lot of residential deliveries,were not bringing in as much revenue asthey had agreed to initially when they nego-tiated discounted rates. The companyincreased the rates for some customers andlost those who would not agree to the ratehikes. In this case the focus is not merely oncustomers, but on profitable customers.When Federal Express says ‘100% customersatisfaction, by performing 100% to our stan-

Expanding global competition isone reason behind the increasedconcern for customer profitability

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dards, as perceived by the customer’, what dothey really mean? Do they always want tosatisfy all customers? With customer prof-itability analysis, increasingly companies likeFed Ex are saying that they do want to satisfycustomers, but they want to do it profitably.They are also anticipating and creating newcustomers for their products and services; forexample Federal Express created theovernight package delivery market and isnow creating another market for same-daydelivery. This is another way that Fed Ex sat-isfies customer demand and maintains prof-itability.

Another company that has benefited fromcustomer profitability analysis is Scotland-based Standard Life Assurance, Europe’slargest mutual life insurance company. Thecompany was stunned when the first resultsof a profitability survey showed that theinsurer was selling policies primarily to thosewho held little potential for making moneyfor the company. Instead of attracting theaffluent customers Standard Life wanted, itsdirect mail marketing campaign was encour-aging older couples and stay-at-home moth-ers to sign up for costly home visits by salesagents. Revenues were higher, but they werethe wrong kind of revenues; these were cus-tomers who typically bought only one policyand the margins were small. Standard Lifewas focused on customers, but was not pay-ing attention to the profitability of each cus-tomer.

Increasing shareholder valueAs the interest in increasing customer satis-faction has grown, so has the interest inincreasing shareholder value. Companies arecompeting globally not only for customers,labourers, and suppliers, but also for capital.This has caused companies to concentrate onsatisfying investors and lenders through anincrease in shareholder value.

First Union is but one example of a companythat has adopted new strategies to increaseshareholder value. Although exceedingcustomer expectations is a worthy goal,companies recognise that exceeding thoseexpectations profitably is necessary for long-term corporate viability. To improvecorporate profitability and shareholder value,companies must have a more completeunderstanding of the drivers of value in their

organisations. To do this, companiesincreasingly focus on the value drivers andon the causal relationships among employeesatisfaction, customer satisfaction, customerprofitability and corporate profitability.Improved corporate profitability requires adeeper understanding of ways to increasecustomer revenues and decrease customercosts. Essential components of improvedcustomer profitability include:

■ the analysis of the cost of customer servicethrough ABC;

■ the measurement of the lifetime value of acustomer; and

■ the development of long-term customerrelationships for increased revenues andprofits.

An important challenge for companies is tomanage customer relationships in order tomake each customer profitable. Bank ofAmerica calculates its profits every month oneach of its more than 75 million accounts;

this permits the company to focus on the10% of its customers that are the most prof-itable. Since it launched the program in1997, customer defections are down andaccount balances in the top 10% have grownmeasurably. Calls from preferred and unprof-itable customers are routed to different oper-ators. A personal identification numberentered by each caller allows the bank todetermine, among other things, the cus-tomer’s profitability ranking. The level ofattention and service will then differ accord-ingly. Bank of America still values customerservice, but also understands that there mustbe a balance between customer service andcustomer profitability.

At First Chicago Corporation, a part of BankOne, profit and loss statements wereprepared for every client, and a $3 teller feewas imposed in 1995 on some of the money-

Companies are competing globallynot only for customers, but also forcapital

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losing customers. Thirty thousand of them,about 3% of the bank’s total clients, closedtheir accounts. Some customers became moreprofitable by increasing their account balancesto avoid the fee or by visiting ATMs instead ofthe tellers. While First Chicago lost somecustomers, it was also able to improve theprofitability of most. Understanding customerprofitability requires an understanding of thecosts of customer service.

Paging Network, Inc., a paging serviceprovider located in Dallas, initially gave awayits pagers to increase market share. Afteranalysing data on individual customers thecompany determined that many customerswere too costly to service profitably. It sentletters to marginal customers increasing therates and subsequently lost 138,000 cus-tomers in the third quarter of 1998. Of theremaining 10.2 million subscribers, it expect-

ed to lose another 325,000 customers beforethe end of 1998. The company determinedthat the cost to service these customers wasgreater than the revenue being generated anddecided to cut its losses.2

Customer satisfaction, loyalty, and value3

Recently, many companies have looked tothe service profit chain model (see Figure 1below) to help them understand the causalrelationships between employees and cus-tomers and the impact on revenue growthand firm profitability. Among the relation-ships that have been documented and mea-sured in this model are:

■ customer satisfaction and loyalty;■ the value of services and goods delivered to

customers;■ employee satisfaction, loyalty, and produc-

tivity; and

FIGURE 1 THE SERVICE PROFIT CHAIN

Internal External

Adapted and reprinted by permission of Harvard Business Review. An exhibit from ‘Putting the Service Profit Chain to Work’ by James L.Heskett, Thomas O. Jones, Gary W. Loveman, W. Earl Sasser, Jr., and Leonard A. Schlesinger, March –April 1994, p.166. Copyright © 1994by the President and Fellows of Harvard College, all rights reserved.

Source: Heskett, Sasser and Schlesinger 1997: 19.

Workplace design

Job design/decision-making latitude

Selection and development

Rewards and recognition

Information and communication

Adequate “tools” to serve customers

Quality and productivityimprovementsyield higher service qualityand lower cost

AttractivevalueServicedesigned anddelivered to meet targeted customers’needs

Lifetime valueRetentionRepeat businessReferral

Operating strategy and servicedelivery system

Service concept Target market

Servicevalue

Satisfaction Loyalty

Profitability

RevenuegrowthSatisfaction

Loyalty

Productivityand

Outputquality

Employees

Service quality

Capability

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■ employee capabilities that aid in deliveringoutstanding results to customers. (Heskett,Sasser, and Schlesinger 1997:18).

Finance and accounting professionals mustunderstand these relationships to be able todevelop links between:

■ the human resource focus on employees;■ the production focus on operations;■ the marketing focus on revenues; and■ the traditional accounting focus on costs.

The integration provides significant value tomarketing and general management execu-tives as they try to improve customer andcorporate profitability. Some of the relation-ships between customers and employees areself-reinforcing, satisfied employees contributeto customer satisfaction, and satisfied cus-tomers contribute to employee satisfaction.

To a customer, value involves the expectedbenefits and costs of a product or service,and the customer’s perception is of signifi-cant relevance. The expected benefits arederived from the product and service attrib-utes and the expected costs include the trans-action costs, the life-cycle costs, and the risk.Transaction costs are typically the immediatefinancial outlay, which includes the price,delivery, and instal-lation costs. The life-cycle costs are theadditional expectedcosts that the cus-tomer will incur overthe life of the prod-uct. The risk is asso-ciated with the life-cycle costs (SMAC1995:3).

Conceptually, theprofit levels generat-ed by customers dueto retention, relatedsales, and referralsare shown in Figure2 (right).

Customers do notdetermine corporatestrategy, but theirvalues and expecta-tions for the compa-

ny’s products and services are influential.Organisations place great value on their cus-tomers and depend on them for long-termviability. Five fundamental customer valueaxioms apply to most companies and helpexplain a customer’s value to the firm:

■ the customer defines the product quality,service quality and acceptable price;

■ customers form their expectations relativeto competitive alternatives;

■ customer expectations change, usuallyupward;

■ product and service quality must extendthroughout the value chain; and

■ maximising customer value requires thatthe whole organisation be involved.(SMAC 1995:7-8).

Customer satisfactionCustomer satisfaction is the perception thatthe products or services received meet orexceed the expectation of the product or ser-vice. This is not an isolated phenomenonand is often considered within the contextof loyalty, retention, and profitability.Researchers have shown that a causal rela-tionship exists between customer satisfac-tion and customer loyalty and that this rela-tionship often leads to increases in prof-itability.

FIGURE 2 WHY CUSTOMERS ARE MORE PROFITABLE OVER TIME

0 1 2 3 4 5 6 7YearCustomer

acquisitioncost

Base profit

Profit from increasedpurchases and higherbalances

Profit from reducedoperating cost

Profit from referrals

Profit from price premium

Com

pan

y p

rofi

t*

Reprinted by permission of Harvard Business Review. An exhibit from ‘Zero Defections: Quality comes to Services’by Frederick F. Reichheld and W. Earl Sasser, Jr. (September-October 1990), p. 108. Copyright © 1990 by thePresident and Fellows of Harvard College; all rights reserved.

*This pattern is based on our experience in many industries.


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Many companies have long held the viewthat customer satisfaction is a prerequisite forlong-term profitability. Increased competitionand maturing markets have made the issue ofcustomer satisfaction more significant.Further, the focus of sales and marketing hasoften shifted from an offensive strategy offinding new customers to a defensive strategyof retaining current customers and increasingthe volume of their purchases (Fornell, Ryan,and Westbrook 1990:14).

A study by American Express Travel demon-strated the relationship between customersatisfaction and profitability. After establish-ing that business travellers from large compa-nies were the most profitable customers,

American Express determined that what thesecustomers valued most was fast service, pro-fessional treatment, experienced agents, andaccurate ticketing. They also found that thoseoffices that delivered the fastest, most accu-rate ticketing were among the most profitable(Heskett, Sasser and Schlesinger 1997:20).

However, satisfied customers can also beunprofitable, as reported by Federal Expressand Page Net, and previously discussed.Individual customer satisfaction does notnecessarily lead to customer profitability.Customer retention, customer loyalty, and customer service costs must also beexamined.

Customer retention and customer loyaltyCustomer retention leads to an ongoing rela-tionship that can yield revenues from thesale of additional products or services. Therevenues become more profitable as the cus-tomer becomes easier to serve. Since the cus-tomer is buying again it is assumed that lesssales effort is required, customer servicecosts decrease, and the costs of acquiringcustomers decline.

Ford Motor Company recently estimated thevalue of customer retention (ie, the percent-age of the firm’s customers buying a Ford asthe next car). Ford’s stated goal was toincrease customer retention from 60% to 80%as the company was convinced that eachadditional percentage point of customerretention was worth $100 million in profits.

Software producer Intuit found the worth of acustomer to be far greater than the customer’soriginal purchase of Quicken software. Therevenue is $30 initially, but increases to sever-al hundred dollars or more as satisfied cus-tomers buy additional products. The revenuescontinue over time while the costs of cus-tomer service decrease.

Customer loyalty encompasses customerretention but also includes the customers’recommendation of the product or service toother potential customers. Word of mouthrecommendation is important to SouthwestAirlines, whose reservation system has neverbeen accessible to travel agents. It has reliedon advertising and customer loyalty to spreadits message to potential customers. The air-line, which began flying in 1971, has consis-tently been profitable. Convinced that cus-tomer loyalty is a more important factor inincreasing profitability than is market share,Southwest Airlines strives to build customerloyalty by providing at low fares dependable,frequent service over relatively short routes,delivered by friendly employees.

The relationship of customer loyalty and cus-tomer satisfaction can be seen in the follow-ing categorisation of customers; it is impor-tant to understand fully the environmentwhich the customer is working, as extrinsicfactors may drive them from one category toanother:

■ apostles – customers who are loyal and sat-isfied and recommend the service to others;

■ mercenaries – customers who may switchservice suppliers to obtain a lower price,but are highly satisfied;

■ hostages – customers who are highly dissat-isfied but have few or no alternatives; and

■ terrorists – customers who have alternativesand use them, and also try to convert othercustomers by expressing their dissatisfac-tion. (Heskett, Sasser, and Schlesinger1997:85).

Individual customer satisfactiondoes not necessarily lead to customer profitability

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The model in Figure 3 (below) shows the rela-tionships between satisfaction and loyalty forthese four groups in different competitiveenvironments.

This model also suggests strategies for invest-ing in customer satisfaction improvementsfor the greatest amount of profit improve-ment. The ‘apostle’ group of customers andthose who are close to being ‘apostles’ shouldbe cultivated and maintained as a valuableresource. This group includes satisfied cus-tomers who also tell others about the prod-uct or service, and can be considered a partof the sales force and a valuable marketingtool. On the other end, the ‘terrorist’ groupcan have a detrimental effect on the compa-ny, since they are vocal in their dissatisfac-tion. Efforts to turn this type of customeraround often prove very beneficial.

Balanced scorecard and the value propositionThe balanced scorecard is a strategic manage-ment system that focuses on the drivers ofprofit, success, and value in organisations. Itlooks at four organisational perspectives andthe causal links among them. In the balancedscorecard, companies identify and measurethe drivers of future performance throughthe identification of key success factors, and

then develop key performance indicators tolink to corporate, business unit, and func-tional strategies. The balanced scorecardincludes financial and non-financial metricsthat incorporate both lagging and leadingindicators of performance. The four perspec-tives of the balanced scorecard are:

■ financial – to succeed financially, howshould the organisation appear to its share-holders?

■ customer – to achieve its vision, howshould the organisation appear to its cus-tomers?

■ internal business process – to satisfy share-holders and customers, at what businessprocesses must the organisation excel? and

■ learning and growth – to achieve the vision,how will the organisation sustain its abilityto change and improve? (Kaplan andNorton.1996: 9).

In the customer perspective (see Figure 4 onpage 10), the organisation identifies the cus-tomer and market segments that will deliverthe revenue component of the company’sfinancial objectives. The customer perspec-tive enables the firm to fine-tune its core cus-tomer outcome measures – satisfaction, loyal-ty, retention, acquisition, and profitability –to targeted customers and market segments.

FIGURE 3 HOW THE COMPETITIVE ENVIRONMENT AFFECTS THESATISFACTION-LOYALTY RELATIONSHIP

airlines

hospitals

personalcomputers

local telephonehigh

low

automobiles

Loya

lty

"Hostages" "Apostles"

"Mercenaries"

completelydissatisfied

satisfaction

completelysatisfied

1 2 3 4 5

Highly competitive zoneCommoditisation or low differentiationConsumer indifferenceMany substitutesLow cost of switching

Non-competitive zoneRegular monopoly or few substitutesDominant brand equityHigh cost of switchingPowerful loyalty programProprietary technology

"Terrorists"


Note: Words in quotation marks have been added by the authors to describe customers exhibiting varying degrees of satisfaction and loyalty. Adaptedand reprinted by permission of the Harvard Business Review. An exhibit from ‘Why Satisfied Customers Defect’ by Thomas O. Jones and W. EarlSasser, Jr., November-December 1995, p.91. Copyright © 1995 by the President and Fellows of Harvard College; all rights reserved.

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Figure 4 (below) suggests that there are causalrelationships within the core measurementgroup. The relationships among customersatisfaction, customer retention, and cus-tomer acquisition have a direct effect on theprofitability of the firm, reducing customercosts and increasing revenues.

The balanced scorecard relies on the valueproposition – that set of unique products andservices that differentiates the company andprovides value to its customers. Analysis ofthe value proposition is essential for under-standing how customers are retained, whatwill satisfy them, and how they can becomemore profitable.

The proposition defines what is unique orvaluable about the company’s product or ser-vice. From the customer’s perspective, thisincludes the attributes of the products andservices that create satisfaction and loyalty

among the customers. The value proposition(see Figure 5 opposite) is the primary conceptfor understanding the drivers of satisfaction,retention, acquisition, and market share.While these propositions will vary significant-ly for different organisations, typically the fol-lowing common attributes are included:

■ product and service;■ customer relationship; and■ image and reputation.

The product and service characteristics of themodel include functionality, price and quali-ty (Kaplan and Norton 1996:73). How welldoes the product work? Is the quality goodenough to keep the customer satisfied? Is theprice too high or too low? A price that is toohigh will discourage customers from buyingthe product in the long run. Perhaps theywill buy it once, but they will not be repeator loyal customers.

FIGURE 4 THE CUSTOMER PERSPECTIVE CORE MEASURES

Reflects the proportion of business in a given market (in terms of number of customers,dollars spent, or unit volume sold) that a business unit sells.

Measures, in absolute or relative terms, the rate at which a business unit attracts or winsnew customers or business.

Tracks, in absolute or relative terms, the rate at which a business unit retains or main-tains ongoing relationships with its customers.

Assesses the satisfaction level of customers along specific performance criteria within thevalue proposition.

Measures the net profit of a customer, or a segment, after allowing for the uniqueexpenses required to support that customer.

Marketshare

Customeracquisition

Customerretention

Customersatisfaction

Customerprofitability

Marketshare

Customeracquisition

Customerprofitability

Customersatisfaction

Customerretention

Source: Kaplan and Norton 1996: 68.

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The relation-ship aspectincludes thedelivery of theproduct or ser-vice to thecustomer andhow the cus-tomer feelsabout purchas-ing from thecompany. Thisrelationshipbetween thefirm and itscustomers isimportant to maintain and often includespost-sale service. Some companies choose toend the relationship between them and theircustomers at the point of sale, such as in thecase of computers and appliances purchasedat discount stores. If these customers areunhappy with the product, they must con-tact the manufacturer directly.

The image and reputation aspect reflectsthose intangible factors that attract a cus-tomer to a company, such as loyalty to abrand name. This aspect provides the compa-ny an opportunity to define itself for its cus-tomers.

The customer value proposition communi-cates throughout the organisation the expec-tations for customer satisfaction, customerloyalty, and consequently customer prof-itability. The proposition is a compilation ofwhat the company believes the customer val-ues and how the firm can deliver this value,as well as a statement about how the compa-ny adds value to its customers through itsproducts and services. An understanding ofthe customer value proposition is critical forboth the balanced scorecard model and cus-tomer profitability analysis.

Benefit of increasing profitability throughunderstanding of causal relationshipsIn 1992, Sears, Roebuck & Co., the largeretailer, lost almost $4 billion. By 1997 itreported a profit of $1.5 billion. While thereare many reasons for the change, the Searsmanagers believed that it was due primarilyto a change in the culture of their business.Sears believed that there was a gap betweenstrategy and day-to-day operations that left

employees uncertain about how they couldcontribute to the company. Sears developedan employee-customer-profit model andexamined how direct and specific effects ofimprovements in employee satisfactionwould improve customer satisfaction, andultimately profitability. After an initialdesign, analysis of substantial data, and test-ing and modifying the original model themanagers made specific measurable conclu-sions: “a 5 point improvement in employeeattitudes will drive a 1.3 point improvementin customer satisfaction, which in turn willdrive a 0.5% improvement in revenuegrowth” (Rucci, Kirn and Quinn 1998:91).

The Sears model was based on the organisa-tional objectives that were developed tobegin a transformation of the company. Thedesire was for Sears to be “a compelling placeto work, to shop and to invest”. The initialmodel included objectives and measures (seeFigure 6 on page 12). Total performance indi-cators (TPI) were developed to test and refinethe model and assumptions about causallinkages between employee attitude and cus-tomer satisfaction and profitability wererefined. As a result of this process, a newmodel was developed and tested, andbecame operational company-wide with the300,000 Sears employees.

Sears’ management believed that this revisedmodel (see Figure 7 on page 12) indicatedmeasurable causal linkages in the relation-ship of employees to customers, and thattheses linkages resulted in increased profit.Sears managers continued to seek detailedinformation from individual customersregarding their “shopping experiences” in

FIGURE 5 THE CUSTOMER VALUE PROPOSITION

+ +Image Relationship

Source: Kaplan and Norton 1996: 74.

Generic model

Value =

PriceQuality TimeFunctionality

Product/service attributes

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FIGURE 6 THE INITIAL SEARS MODEL: FROM OBJECTIVES TO MEASURES

A compelling place to work

Ob

ject

ive

Mea

sure

■ Environment for personalgrowth and development

■ Support for ideas andinnovation

■ Empowered and involvedteams and individuals

■ Personal growth anddevelopment

■ Empowered teams

A compelling place to shop

■ Great merchandise atgreat values

■ Excellent customerservice from the bestpeople

■ Fun place to shop■ Customer loyalty

■ Customer needs met■ Customer satisfaction■ Customer retention

A compelling place to invest

■ Revenue growth■ Superior operating

income growth■ Efficient asset

management■ Productivity gains

■ Revenue growth■ Sales per square foot■ Inventory turnover■ Operating income margin■ Return on assets

Source: Rucci, Kirn and Quinn 1998: 89.

FIGURE 7 THE REVISED SEARS MODEL: THE EMPLOYEE-CUSTOMER PROFIT CHAIN

A compelling place to work

A compelling place to shop

A compelling place to invest

5 unit increase in employee attitude

DRIVES 1.3 unit increase in customer impression

DRIVES 0.5% increase in revenue growth

Source: Rucci, Kirn and Quinn 1998: 91.

Attitude about the job

Employeebehaviour

Servicehelpfulness

Merchandisevalue

Customerimpression

Customerretention

Customerrecommendations

Return on assetsOperating marginRevenue growth

Employeeretention

Attitude about the company

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order to learn more about customer satisfac-tion and retention, which they believeddirectly affected profitability. When employ-ees saw how their actions with customersmattered to the company, positive attitudeswere reinforced and the linkage was identi-fied between improved attitude towards thefirm and its customers and overall improvedprofitability of the company.

In the five-year period from 1992-1997 man-agement changed the profitability of Sears byaccomplishing the following:

■ trained the workforce to understand thebusiness;

■ held town-hall meetings to explain com-petitive reality to employees;

■ built commitment to a new vision: “tobecome a compelling place to work, shop,and invest”;

■ created a measurement and reward systemto support the vision; and

■ substantially improved customer satisfac-tion and net margins (3.3% vs 1.2% previ-ously). (Rucci, Kirn and Quinn 1998: 97).

Though it is often difficult, there is a need tomeasure customer satisfaction, loyalty, andvalue continually, along with the causal rela-tionships among employees, customers andprofits in order to provide for continued cor-porate profitability. This analysis is funda-mental to understanding the revenue andcost components of customer profitability aswell as the drivers of profits and success inorganisations.

Analysing customerprofitability

How ABC improves understanding ofproduct and customer profitabilityTraditional cost accounting assumes thatproducts and services cause costs to occur.Therefore, direct labour, direct material andother direct costs are traced directly to prod-ucts. All other costs are considered indirectcosts and allocated to products on arbitrarybases, such as product volume or directlabour hours. This costing system can workwell as long as indirect costs and productdiversity are minimal. As the product mix

becomes more diverse, it becomes more diffi-cult to allocate overhead costs accurately.

Activity-based costing assumes that activitiescause costs and that product, services andcustomers are the reasons for the activities.ABC focuses on determining what causes

costs to occur rather than on merely allocat-ing what has been spent. ABC traces costs toactivities in the production process usingresource drivers and activity drivers based oncause and effect. There are five primary stepsin the ABC costing process:

■ identify activities;■ identify resource measures (inputs) from

the consumption of resources by the activi-ties;

■ identify activity measures (outputs) bywhich the costs of a process vary mostdirectly;

■ calculate the driver rate; and■ trace activity costs to cost objects such as

products, processes and customers basedon the usage of activities.

ABC has developed into a broad-based toolthat provides information on many aspectsof company functions in addition to productcost data. ABC can show how products,brands, customers, customer groups, facili-ties, regions or distribution channels bothgenerate revenue and use company resources(Cooper and Kaplan 1991:130). Though not acomplete solution to all business problems, agood ABC system provides useful informa-tion that, in conjunction with other manage-ment information, can facilitate improvedbusiness decision making.

ABC offers a new way to analyse the alloca-tion of costs to non-production activitiessuch as marketing, selling, distribution andadministration. Customer profitability is

ABC focuses on determining whatcauses costs to occur rather than onmerely allocating what has been spent

14



more easily determined through the use ofABC, since the costs can be driven directly toindividual customers, some of whom placemore demands on the company than others.Some may require special orders, purchasejust-in-time inventory, or have special deliv-ery requirements, each of these has a costthat can be allocated to the specific customer

using activity-based drivers. Understandingthe needs and costs of each client, and howeach impacts corporate profitability, can helpto determine the level of customer servicethat will benefit both the customer and thecompany. The special needs of both large andsmall customers can be accommodatedthrough a better understanding of the driversof both the revenues and the costs associatedwith each customer (Kaplan and Cooper1998:181).

Customer profitability analysisTypically traditional cost accounting is notable to identify product and service costs ordistribution and delivery costs for individualcustomers. ABC can help identify customeractivities and track those costs that are allo-cated to specific customers. This can providemanagement with unique information aboutcustomers and customer segments. The bene-fits include:

■ protecting existing highly profitable cus-tomers;

■ repricing expensive services, based on cost-to-serve;

■ discounting to gain business with low cost-to-serve customers;

■ negotiating win-win relationships thatlower service costs to co-operative cus-tomers;

■ conceding permanent loss customers tocompetitors; and

■ attempting to capture high-profit cus-tomers from competitors (Kaplan andCooper, 1998:181).

Customer profitability analysis has becomean important new management accountingtool based on a recognition that each cus-tomer is different and that eachdollar/pound of revenue does not contributeequally to the firm’s profitability. Customersutilise company resources differently; thuscustomer costs vary from one customer toanother. The following issues should be con-sidered when analysing customer profitabili-ty:

■ how to develop reliable customer revenueand customer cost information;

■ how to recognise future downstream costsof customers;

■ how to incorporate a multi-period horizonin the analysis; and

■ how to recognise different drivers of cus-tomer costs. (Foster, Gupta and Sjoblom1996:10).

This requires a broader examination of thecosts associated with customer service. Forexample, post-sale customer service costsmust be included in any analysis of customercosts. Some customers require substantiallymore post-sale service than others. In addi-tion, future environmental liabilities relatedto the sales of current products are addition-al downstream costs that must be included.With management’s increased focus on cus-tomers, this analysis can provide forward-looking information about individual cus-tomers and customer segments and morebroadly examine both the revenues andcosts related to customer transactions.Revenues can vary among customers due tovariations in volume levels, and differencesin price structures, products and services.

Costs can also vary depending on how cus-tomers use the company’s resources such asmarketing, distribution, and customer service.Unless a complete analysis of the benefits andcosts of customer relationships is undertaken,companies will unknowingly continue to ser-vice unprofitable customers. Only after athorough analysis of the costs and benefitscan a firm decide which customers to serviceand strategically price its products and ser-vices.

There are many costs that are often hiddenwithin the production, support, marketing,and general administrative areas. To better

ABC can help identify customeractivities and track those costs thatare allocated to specific customers

15



understand customer prof-itability these costs should beexamined and assigned appro-priately using ABC methods.These currently hidden cus-tomer costs may include itemssuch as:

■ inventory carrying costs;■ stocking and handling costs;■ quality control and inspec-

tion costs;■ customer order processing;■ order picking and order ful-

filment;■ billing, collection and pay-

ment processing costs;■ accounts receivable and car-

rying costs;■ customer service costs;■ wholesale service and quali-

ty assurance costs; and■ selling and marketing costs.

(Weinberg 1999:28).

ABC was recently used by atelecommunications companyto improve customer prof-itability. The company devel-oped a process for identifyingthe drivers of training costs,which is an important compo-nent of the company’s con-tract bids. The company’sactivities included the sub-mission of bids to largeorganisations for the installa-tion of telecommunicationssystems. The bids were rea-sonably accurate in estimat-ing the cost of the equipmenthardware, the installationcost of the new equipment,and the programming costs.However, the cost of trainingthe customer’s employees about the newequipment was more difficult to determine.Figure 8 (on pages 16 and 17) represents anoutline of the customer profitability report-ing system developed for one business unitof this company (Ortman and Buehlmann1998). This is an example of a detailed, com-prehensive, and somewhat costly approach.As always there must be a balance betweenthe benefits of collecting additional data andthe associated cost. The availability and

timeliness of data are also significant issuesin implementing customer profitability sys-tems based on ABC.

The major marketing activities were identi-fied and the resources that these activitiesconsumed were detailed. Employee time wasthe major resource driver, and was traced byan employee log to specific activities. Thecompany found that training costs were sig-nificant but difficult to calculate. Customer

16



FIGURE 8 OUTLINE OF THE CUSTOMER PROFITABILITY SYSTEM

Resource drivers Method of tracingresources to activitiesand customers

Activities

I. Selling

1) Account executives’ (AE) salariesand benefits

2) Account executives’ (AE) commissions

3) Presentation materials (brochures,videos, CD Roms)

4) Depreciation on presentationequipment

5) Demonstration facilities expense 6) LD telephone expense7) Automobile expense8) Travel expenses9) Entertainment expenses

10) Sales support/occupancy costallocation

11) Sales manager’s salary and benefits

time spent

sales closed

items given away

time used

time usedcalls mademileagedistance and timeentertainingdone/time spentnone

none

log

commission report

log

log

loginvoiceloginvoice/loginvoice/log

allocation using AE’s

traceable time

Selling activities

1) Maintaining current customer relations

2) Generating new customers

3) Making customer presentations

4) Conducting demonstrations

5) Entertaining customers6) Forming support teams

to prepare an RFP7) Attending new product

training seminars

II. Technical support

1) Technical design specialists’ (TDS)salaries and benefits

2) LD telephone expense3) Travel expenses4) Computer costs including software5) Sales support/occupancy

cost allocation6) TS manager’s salary and benefits

time spent

calls madedistance and timetime usednone

none

log

invoiceinvoice/loglogallocation using TDS’s

traceable time

Technical support activities

1) Determining the cus-tomer’s hardware and software needs; installationprocedures and cost esti-mation thereof

2) Researching new products

III. Customer support

1) Customer Support representatives’(CSR) salaries and benefits

2) Training materials:■ Development costs■ Duplication costs

3) Automobile expense4) Travel expenses5) LD telephone6) Sales support/occupancy

cost allocation7) CS manager’s salary and benefits

time spent

time spent# printedmileagedistance and timecalls madenone

none

log

loginvoiceloginvoice/loginvoiceallocation using CSR’s

traceable time

Customer support activities

1) Estimating customer training costs

2) Conducting customertraining

3) Collecting data needed forsoftware programs

4) Analysing customer needsfor options and upgrades

5) Handling customer com-plaints

6) Attending new producttraining seminars

Marketing resources

Source: Ortman and Buehlman1988:8

17



service representatives, who were at the frontline in the training function and formed aliaison between the company, its customersand the engineers who designed the sys-tems, were interviewed. The company wasthen able to identify seven different trainingactivities and resource uses, along withpotential cost drivers. The estimation of cus-tomer service training costs through the useof ABC improved the company’s under-standing of the profitability of its differentcustomers.

Whether customer-specific costs are neces-sary and/or can be determined depends onseveral factors, including the fragmentationof the customer base, the cost structure ofthe company, and the existence of the neces-sary information infrastructure. Analysis canbe crude and simple and even incomplete,yet still effective at providing valuable cus-tomer profitability information.

Some customer models have been developedto provide companies with a framework to

FIGURE 8 (continued from previous page)

Marketingresources

Resource drivers Method of tracingresources to activitiesand customers

Activities

IV. Customer service

1) Service specialists’ (SS) salaries and benefits

2) Service specialists’ commissions (on service contract sales)

3) Automobile expense4) Travel expenses5) Telephone (LD)6) Sales support/occupancy

cost allocation7) CS manager’s salary and benefits

time spent

value of contractssoldmileagedistance and timecalls madenone

none

log

commissionreportloginvoice/loginvoiceallocation using SS’s

traceable time

Customer service activities

1) Installing new systems;adding options andupgrades to existing systems

2) Selling maintenance contracts on new equip-ment and renewals on exist-ing equipment

3) Providing repair and maintenance services

4) Learning how to servicenew products

V. Sales support

1) Clerical staff’s salaries including benefits

2) Occupancy costs■ Lease, utilities, telephone■ Cleaning contract expense■ Leasehold improvement

amortisation3) Equipment depreciation

■ Computers■ Fax/copying machines■ Office furniture■ Software amortisation

4) Office supplies5) Receptionist’s salary and benefits6) SS manager’s salary and benefits

time spent

none

none

nonenonenone

log

Allocated to four

areas above in

proportion

to the CS’

time traceable

to those areas

Sales support expenses

1) Maintaining office facilities2) Providing word processing,

copying, faxing services3) Providing receptionists

services4) Providing facilities for staff

training5) Providing facilities for cus-

tomer demonstrations6) Providing payroll input data7) Preparing budget for

corporate8) Distributing incoming mail,

preparing outgoing mail

Source: Ortman and Buehlman1988:8

18

analyse the pricing of different servicesfor different types of customers. Anexample of such a model can be seen inFigure 9 (below).

This customer-based ABC model facili-tates company analysis of how to be aprovider to customers that desire lowcost products and minimal service andalso how to provide services to highmargin, high cost-to-service customers.Thus profitable customers can beacquired and retained in many differentways. Increasingly, companies are utilis-ing menu-based pricing where the costto the customer is determined by boththe amount and type of products pur-chased and by the delivery method andcustomer service costs. Menu-based pric-ing is based on an ABC model thatdetermines the customer service costsand delivery costs (Kaplan and Cooper,1998:193-194).

Pillsbury, the giant food distributor, used

information from its ABC customer andstore level profit and loss statements todetermine what its customers valuedand wanted and then developed “menu-based pricing”. The company begancharging fees for special services thatwere desired by some but not all cus-tomers. In this way it developed a baselevel of service that all customersreceived, plus service-based pricing forspecially desired services. Further savingsto consumers were obtained throughnegotiations with retailers for lowerprices on Pillsbury products and for spe-cial merchandising and promotion of itsproducts (Kaplan and Cooper 1998:198).

Swedbank, part of the largest bank groupin Sweden, resulted from a consolidationof several government-owned banks.There were 4.5 million individualaccounts and 100,000 business accounts.This is an example of a customer servicecompany that made use of customerprofitability analysis to identify itsunprofitable customers and to becomemore profitable overall. Through ABCanalysis and customer surveys, the bankdetermined that approximately 80% ofits customers were satisfied but unprof-itable, while the remaining some 20% ofthe customers were dissatisfied with thebank’s services but very profitable – con-tributing more than 100% of the bank’sprofits. As a result, the bank beganinvesting all new capital in profitablecustomers. Front line employees weregiven more latitude, new products wereintroduced, employee training wasincreased, and a new management infor-mation system was introduced to cus-tomer and corporate profitability. Someunprofitable customers left and the prof-itable customers increased their usage ofthe bank’s products and services.

Swedbank proceeded to examine therelationships and results of three relateddimensions of performance: customervalue added, people value added, andeconomic value added (profitability).This combination of an ABC analysiswith a balanced scorecard type modelprovided the framework and the infor-mation to improve customer and corpo-rate profitability.



FIGURE 9 CUSTOMER PROFITABILITY

Passive■ Product is crucial■ Good supplier match

Aggressive■ Leverage their buying

power■ Low price and lots of

customised features

Price sensitivebut fewspecialdemands

Costly to service,but paytopdollar

Profit

s

Losses

Low

Low

High

High

Cost-to-serve

Net

mar

gin

rea

lise

d

Source: Adapted from B.P. Shapiro, V.K. Rangan, R.T. Moriarty, and E.B. Ross, ‘ManageCustomers for Profits (Not Just Sales)’ Harvard Business Review (September-October1987), 104. Reprinted by permission of Harvard Business Review.

Source: Kaplan and Cooper 1998:193.

19



Customer profitability analysis in a manu-facturing companyThe Kanthal case provides an excellent exam-ple of how ABC can improve the measure-ment and management of customer prof-itability. Kanthal, the largest division ofSwedish manufacturer Kanthal-Hoganas, hadsales in excess of $50 million per year. Mostsales, about 95%, were exports from Sweden.Kanthal manufactured and sold heatingalloys for electric resistance heating elements,heating elements for industrial furnaces andthermo-bimetals for temperature controldevices. The company was organised intothree divisions, two of which held substantialglobal market shares in their particular prod-ucts and the other had developed a fullyintegrated manufacturing system to producethe thermo-bimetals.

The president of the company, Carl-ErikRidderstale, saw the need for a strategic planto increase profits while maintaining anannual return on employed capital in excessof 20% (Kaplan 1989:2). His ‘Kanthal 90Strategy’ detailed profit objectives by divi-sion, product line, and market share.Ridderstale’s plan was to achieve this growthwithout the need for additional sales oradministrative staff to handle the expectedincrease in sales volume.

Ridderstale was also concerned that sellingand administrative expenses formed thelargest cost category in the company andwere growing. They accounted for 34% oftotal expenses and were treated as periodcosts rather than allocated to either productsor customers. Ridderstale wanted a new cost-ing system that could determine how muchprofit was earned every time an order wasplaced. He also wanted to find the hiddenprofits and hidden costs in each order.Further, he believed that Kanthal had lowprofit and high profit customers dependingon the demands that the customer placed onthe administrative and sales staff and thatthese customers should be readily identifi-able.

Kanthal had about 10,000 customers andproduced over 15,000 items. It stocked 20%of those (3,000 items) which represented80% of the company’s sales. After assigningcosts to customer orders, it became apparentthat the sales of stocked items were signifi-

cantly more profitable than the processingand manufacturing of non-stocked items.Since the existing system did not differenti-ate between orders for stocked and non-stocked items the difference in profitabilityhad not been apparent. The costs to producenon-stocked items was greater than the coststo produce stocked items since special sched-uling was required for the purchase of theraw materials and the production process. Itwas also more costly to produce the items insmall quantities.

With the aid of consultants, the financialmanager of Kanthal, Per O. Ehrling, devel-oped an account management system toanalyse production, sales, and administrationcosts using ABC. Two new cost drivers wereadded to the analysis: the additional cost ofproducing non-stocked items, and, the nor-mal expense associated with any customerorder such as pricing, scheduling delivery,invoicing, and collecting.

The company then accumulated, for eachcustomer, the profit and loss figures fromeach individual order placed by that cus-tomer (see Figure 10 below). The results of theABC analysis showed that while gross mar-gins for different customers may be the same,the additional costs to produce special smallorders and to fill stocked items on smallorders significantly reduced the profitabilityof these customers. Kanthal now realised that

FIGURE 10 CUSTOMER PROFITABILITY: RANKED FROM MOST TO LEAST PROFITABLE

-200

-150

-100

-50

0

50

100

150

200

1 2 5 10 20 40 60 80 100 120 140 160 180190 195 198 199 200

Number of customers

P-Vol

Source: Kaplan 1989:13.

20



FIGURE 11 CUSTOMER ORDER ANALYSIS

CountryCustomer

SwedenS001S002S003S004S005S006S007S008S009S010S011S012S013S014S015S016

Order Lines

1389152118281222

InvoicedValue (SEK)

1,21046,18451,10298,8803,150

24,1044,8602,705

51867,9584,105

87,8651,2741,813

37,0606,500

VolumeCost(SEK)

54310,08050,56760,7851,557

14,8892,6571,194

23351,9531,471

57,581641784

15,9746,432

OrderCost(SEK)

5721,7164,5765,148

5722,8601,144

572572

4,5761,1444,576

5721,1441,1441,144

Non-Stocked (SEK)

04,524

12,06413,5722,3404,6804,680

00

12,0640

12,0642,340

03,0163,016

OperatingProfit(SEK)

9529,864

(16,105)19,375(1,319)

1,675(3,621)

939(287)(635)1,490

13,644(2,279)

(115)16,926(4,092)

ProfitMargin

8%65

-3220

-427

-7535

-55-13616

-179-646

-63

Note: All financial data reported in Swedish kroner (SEK).Source: Kaplan 1989:11.

FIGURE 12 CUMULATIVE PROFITABILITY BY CUSTOMERS

0

50

100

150

200

250

100999590807060504030201510510

Cumulative profits

Cumulative % of customers

Pro

fits

: %

of

tota

l

21



it had a few extremely profitable customersand a few extremely unprofitable ones(Kaplan and Cooper 1998: 185) and was sur-prised by the wide variation in customerprofitability. Figure 10 graphically portraysselect Kanthal customers and how they addor detract from profitability. Generally, thefirst few customer sales vs cost of sales con-tributed the most profit, while the last fewcustomers generated the largest losses due tohigh selling or post-sale costs.

Even more surprising to Kanthal was thatsome of the customers with the most saleswere the most unprofitable. Two very unprof-itable customers were in the top three interms of sales volume. One of these unprof-itable high volume customers had moved tojust-in-time (JIT) ordering from its suppliers,placing orders weekly and sometimes twice aweek. Variations in the profit margins onindividual orders ranged from -179% to+65% as shown in Figure 11 (opposite).

The company also discovered that 40% ofthe Swedish customers generated 250% ofthe profits. Finally, it also discovered that themost profitable 5% of the customers generat-ed 150% of the profits. This was a shockingdiscovery as it had been thought that mostcustomers contributed to profit. This phe-nomenon of a few customers being the mostprofitable is present in many companies.

Traditional cost accounting often supports a20-80 rule that 20% of the largest customers,who purchase the most products, contribute80% of the profits. Using ABC, analysts haveoften found that 20% of the customers gen-erate 300% of the profits. The remaining 80%of the customers are actually unprofitableand can result in a loss of 200% of the prof-its. When plotted on a graph, (see Figure 12opposite), the ‘hump’ of this ‘whale curve’indicates the profit earned by the company’smost profitable customers. The remainingcustomers are break-even or unprofitable andbring the overall profit back down to 100%.The goal is to make each customer profitable.

With a new understanding of which cus-tomers were profitable and which were not,Kanthal became dedicated to turning unprof-itable customers into profitable ones. Thecompany developed ways to retain the cus-tomers and decrease their administrative and

selling costs (Kaplan and Cooper 1998: 188).In the short term, Kanthal tried the follow-ing: reduce the size of its product lines,accept orders only for stocked items, useexternal distributors to reduce the cost ofsmall accounts, change compensation tosalesmen to emphasise profit rather thanonly sales volume, and engineer to reduceset-up times and improve operational effi-ciencies.

In the longer term, the following are some ofthe actions taken as a result of the new ABCsystem:

■ involvement of salespersons was increasedin discussions with management and cus-tomers;

■ prices were increased for small, customisedorders;

■ product managers were encouraged toreduce proliferation of sizes and variancein product line;

■ salespersons emphasised standard prod-ucts; and

■ customers were persuaded to make largerorders of stocked items.

With one particular customer, customer #200(see Figure 10 on page 19), Kanthal devised anexcellent solution that would make the com-pany profitable and satisfy the customer. Thecompany went to the customer, shared theABC analysis, and explained the implications

for profitability of producing only smallorders of non-stocked items. Kanthal offereda new pricing structure that granted the cus-tomer a 10% discount on high volume ordersof stocked products and charged a 60% pricepremium for small orders of non-stockeditems. The results of this new pricing struc-ture were reviewed one year later; Kanthalfound that customer #200 gave the companythe same volume of business but placed

Using ABC, analysts have oftenfound that 20% of the customersgenerate 300% of the profits

22



orders half as many times per year, and forhalf as many different products. Customer#200 changed from the most unprofitablecustomer into one of the most profitable inthe course of one year (Kaplan and Cooper1998:188).

Kanthal’s approach was to work with its cus-tomers for the benefit of both the firm andthe customer. The company provided somecustomers with computer terminals directlylinked to the Kanthal office so the customerscould order directly without any sales effortbeing employed. Another customer, who hadplaced several small orders for many differenttypes of products, was converted to a distrib-utor. Kanthal sold larger quantities to thecustomer that stocked the items for its ownuse. This customer also added a profit tosome of the products and resold them toother small companies. Thus Kanthal wasthus able to reduce its service costs to thisone customer and better service other smallcompanies.

In these instances, Kanthal discovered, likemany other companies, that rapid improve-ments in information technology could simul-taneously provide substantial benefits to bothcustomer service and customer profitability.Further, companies have recognised that cus-

tomer behaviour, satisfaction, and profitabilitycan all be increased when this new informa-tion on customer profitability is shared direct-ly with the customer.

The ability to determine customer profitabilityon an individual basis can add value to thecompany-customer relationship. As in the caseof Kanthal, the customer can be helped toreduce its costs and the company can becomemore profitable. Increasingly with ABC, man-agement of activities is the focus – costaccounting becomes more about managingcosts (rather than cost accumulation), know-ing what causes costs to occur, and makingchanges to reduce expenditures. Kanthal was

able to work with its existing customers fortheir mutual benefit.

Using customer profitability analysis to deter-mine the causes of costs and then makingchanges to reduce those costs are importantlessons to be learned from the Kanthal case.Customer profitability can only be increasedby reducing costs or raising revenues. Ways toincrease that profitability through better man-agement of customer costs are facilitated byimproved cost analysis. In this case, an ABCanalysis was critical. The managers wereunwilling to take any action until they werepresented with the data that indicated theprofitability of products and customers.

Customer profitability analysis in a servicecompanyThe Co-operative Bank was founded inEngland in 1872 as a department in a co-oper-ative wholesale society, which was the centralorganisation formed by co-operative societiesthroughout the country. Co-operative societieswere formed to aid working class people inobtaining goods and services at lower coststhrough trade and co-operation. The bank’smain function was to serve the banking needsof the wholesale cooperatives and thus hadfew personal accounts. It expanded to servemany of the upcoming and growing co-opera-tive societies around the country.

In 1971, an Act of Parliament established thebank as a separate legal entity. The co-opera-tive movement had declined along withdeposit and loan accounts due to competitivepressure from private businesses. Reorganised,the bank began to aggressively pursue depositsfrom personal customers and by the 1990shad deposits of approximately £3 billion. Asthe bank grew, it also broadened the range ofproducts and services for personal and corpo-rate customers. Increased competition fromother banks and customer demand led to newproducts being introduced including creditcards, high-interest bearing current accounts,ATM cards, telephone banking and indepen-dent financial advice.

Under new management, the Co-operativeBank issued both a mission statement and astatement of ethical policy. These documentsdeclared the bank’s responsibility to itscustomers, its employees and its communities,and promoted the co-operative values

Customer behaviour, satisfaction andprofitability can all be increased

23



established at the founding of the bank in1872. In the early 1990s, Co-operative Bankfound itself in the midst of an economicrecession and was forced to make changes toits operations in order to be more competitiveand efficient. It consolidated some operationsand reduced employment through voluntaryretirement. However, it also increased its cross-selling activities to existing customers andbegan to offer a much wider choice ofproducts. While the bank believed it had anarray of excellent products and services for itscustomers, its cost-to-income ratio was higherthan its competition. Traditional responsibilityaccounting was being used to measureexpenses for geographic and departmentalcost centres but the bank was unable to trackcosts to customers or to products.

In 1993, the Co-operative Bank began anambitious project to improve its profitabilityand customer service. The goal of the new‘Project Sabre’ was to improve the cost-to-

income ratio and the service to customers. Inorder to accomplish this, the bank neededadditional information for making changesthat related to five corporate needs:

■ overhead reduction;■ re-engineering of business processes, partic-

ularly those that did not add value to cus-tomers;

■ product profitability;■ customer profitability; and■ segment profitability (Datar and Kaplan,

1995:5).

The bank began an ambitious project ofimplementing ABC. It identified 210 costpools and 235 activities/tasks. The bank thenasked employees from different areas of thebank to match resource costs to the activitiesby identifying the amount of time that theyspent on various activities. A sample of theactivities, cost drivers, quantities, and ratesare displayed in Figure 13 (below).

FIGURE 13 PERSONAL SECTOR PRODUCTS: ACTIVITY COSTDRIVERS QUANTITIES AND RATES*

Activity description

Provide ATM serviceClear debit itemsBranch operations for debit itemsIssues personal cheque bookClear credit itemsBranch operations for credit itemsLending control and securityCustomer inquiriesCustomer correspondenceMarketing and sales activityComputer processing

Statementing and postageAdvise on investments and insuranceProcess VISA transactionsIssue VISA statementsOpen/maintain handyloansOpen and close accountsAdminister mortgages

Activity cost driver

ATM transactionsNumber of debits processedNumber of branch counter debitsNumber of books issuedNumber of credits processedNumber of branch counter creditsNumber of interventionsNumber of telephone minutesNumber of customer lettersNumber of accounts openedNumber of computer transactions (electronic impulses)Number of statements issuedHours of advice givenNumber of VISA transactionsNumber of VISA statements issuedNumber of handyloan accountsNumber of accounts opened/closedNumber of mortgages

*Numbers disguised to maintain confidentiality.Source: Datar and Kaplan 1995: 16.

Totalactivity

cost

£ 490,3021,022,140

684,100263,949218,001548,168

1,380,7631,298,801

726,2062,562,0461,641,247

477,2001,159,9431,174,207

443,107846,806493,599196,082

£15,626,667

Quantityof activity

costdriver

1,021,9635,110,299

762,11140,628

871,004512,986765,591

7,205,560221,20462,120

16,112,471

1,724,28532,956

5,125,2481,714,258

201,52157,95118,609

Cost perunit ofactivity

cost driver

£0.480.200.906.500.251.071.800.183.28

41.240.10

0.2835.20

0.230.264.208.52

10.54

24



The total costs of each activity were deter-mined by combining all of the resource poolcosts assigned to each activity. The costs ofeach activity were then traced to the variousbank products by defining activity cost dri-vers for each activity. The activity cost driverrepresented the event that triggered the per-formance of each activity, such as a depositthat was processed or an account that wasopened. The bank was then able to distributethe activity costs to various bank products.Some banking expenses, sustaining costs rep-resenting 15% of the total costs, were notallocated to activities or bank products. These

costs were spread over the entire product andcustomer service range of activities. An analy-sis of product profitability was one of theresults, as set out in Figure 14 (opposite).

The profitability analysis provided the bankwith vital information to make decisionsabout product offerings, strategy and futuregrowth. The analysis showed that theIndependent Financial Advice/Insuranceproduct considered by the bank to be a high-ly profitable business was actually losingmoney. Current Account Plus, the basic coreproduct of the bank, was not profitable. Thebank now had a wealth of informationabout the cost of each activity (the cost toprocess cheques and credit card transac-tions, open and close accounts) and withthis information the bank could reassess itsproduct and service offerings. The bankrealised that it had the highest cost-to-income ratio of UK banks and had to cut itscosts and services in order to survive. Aweakness of the product profitability analy-sis was that it ignored the cross-sellingopportunities of the different products thatthe bank offered. For example, theIndependent Financial Advice/Insuranceproduct while unprofitable may be attractiveto wealthy account holders, help to retainthose customers and ultimately increase theirlifetime profitability.

The initial analysis was limited to productprofitability and the bank’s team wanted toextend the ABC analysis to customer prof-itability by examining individual customerswith current accounts. Specific assumptionswere made in the allocation of the costs ofthe customer accounts. The team allocated55% of current account expenses to transac-tion costs and 45% to account maintenance.Customers were segmented into low, mediumand high based on the turnover of funds intheir accounts in order to allocate the trans-action costs. On the revenue side, the bankdetermined the income earned from the bal-ances and fees for individual customers. Bymatching income with the allocated costs,managers were now able to estimate the prof-itability of each customer. This revealed thatup to half of all current accounts, particularlythose with low balances, were unprofitable.

In service organisations such as Co-operativeBank, costs are usually committed far inadvance. Thus there is little incremental costor savings from reducing or increasing cus-tomer service or activity. Each customer useseach bank product differently, so it is important to have substantial customeranalysis information. For a chequingaccount, some customers write a lot ofcheques and some do not; some customersmaintain high balances and some maintainonly minimal balances.

Once the information on product and cus-tomer profitability is obtained, what shouldmanagement do with it? The bank devisednew strategies for profitability such as:

■ cross-sell more profitable products; ■ distinguish between new customer and

mature accounts;■ switch unprofitable customers to ATM

transactions;■ set pricing for minimum balances, ATM

fees, and overdrafts; and■ outsource ATM network, computer opera-

tions and cheque clearing.

The Co-operative Bank used ABC to betterunderstand the costs of its wide range ofproducts and its diverse customers. Prior tothe ABC implementation, bank managementwas unable to agree on which were theprofitable and unprofitable products andcustomers. The information from both the

In service organisations, costs areusually committed far in advance

25



product profitability analysis and thecustomer profitability analysis for individualcustomers and customer groups was essentialto improving customer and corporateprofitability.

Customer profitability analysis in a smallcompanyCustomer profitability analysis applies tosmall companies as well. When MahanyWelding Supply, a Rochester, New York dis-tributor of welding supplies, examined cus-tomer profitability, there were some surprises.The company employs only seven people.However, Mahany found a wide range in theprofitability of both customers and employ-ees.

Mahany identified four distribution methodsfor its products:

■ walk-in trade and customer pick-up calls;

■ a delivery truck that services customerswithin the city;

■ a delivery truck that services the area with-in a 40-mile radius of Rochester and visitsone of five different geographic areas eachday; and

■ UPS and common carrier shipments(Krupnicki and Tyson 1997:40).

Employee profitability was analysed. Sincethere were only seven employees, jobs werecross-functional; employees often had morethan one job, and no set time to do a partic-ular job. Possible causal relationships amongthe costs the activities and the drivers of theactivities were identified.

Activities were analysed based on the timespent per employee. Other expenses such asadvertising, telephone, legal and accounting,insurance, rent and utilities were also trackedand included in the analysis.

FIGURE 14 PROFITABILITY ANALYSIS OF PERSONAL SECTOR PRODUCTS*

Activity

Net

interest

Net

commission

Bad debts

Gross profit

Activity costs

(from Figure 13)

Direct profit

Allocated

infrastructure

costs

New profit

Freeflow

£1,041,384

358,867

(130,000)

1,270,251

225,472

1,044,779

36,845

£1,007,934

Current

Account

Plus

£5,283,472

3,593,898

(782,000)

8,095,370

7,157,339

938,031

1,014,145

£ (76,114)

Mortgages

£ 331,027

147,909

(274,000)

204,936

144,092

60,844

4,213

£ 56,631

Personal

loans

£ 4,530,763

780,608

(1,192,000)

4,119,571

1,342,626

2,776,945

204,822

£ 2,572,123

VISA

Affinities

£ 463,204

686,117

(182,000)

967,321

439,753

527,568

22,086

£ 505,482

VISA

Classic

£2,856,713

2,101,002

(882,000)

4,075,715

1,914,764

2,160,951

156,768

£2,004,183

VISA

Gold

£ 808,592

1,562,720

(508,000)

1,863,312

1,031,437

831,875

81,053

£ 750,822

Handy-

loan

/Fastline

£1,811,526

65,987

(274,000)

1,603,513

983,569

619,944

20,864

£ 599,080

Deposit

products

£960,437

(1,141)

0

959,296

359,141

600,155

59,685

£540,470

Total

£18,349,035

10,849,885

(4,224,000)

24,974,920

15,626,667

9,348,253

1,928,625

£ 7,419,628

Indepe-

ndent

Financial

Advice/

Insurance

£ 0

1,549,634

0

1,549,634

1,601,707

(52,073)

263,078

£ (315,151)

Pathfinder

£ 261,717

4,284

0

266,001

426,767

(160,766)

65,066

£(225,832)

* Numbers are disguised to maintain confidentiality.Source: Datar and Kaplan 1995: 18.

26



The analysis, though not precise, has provid-ed the company with substantially improvedinformation for decision making, andchanged the way the company looks at alter-natives for servicing customers and pricingservices to make them more profitable.

The ABC analysis indicated that 15 differentactivities caused costs to occur in the compa-ny. Once the activities were identified, timestudies performed, a causal link foundbetween activities and costs, allocation ratescomputed, and the data put into a contribu-tion margin format the desired cost numberswere obtained. The analysis provided valuableinformation to improve cost management bymore carefully identifying the costs of servic-ing different customers. It also illustratedsome important lessons related to the use ofABC and customer profitability analysis:

■ information, though not precise, can pro-vide the company with substantiallyimproved support for decision making andgreatly improve its understanding of cus-tomer profitability;

■ a company does not necessarily need excel-lent ABC analysis to make great improve-ments; and

■ no ABC information/analysis is perfect.Good judgment and additional qualitativeinformation are necessary before final deci-sions are made.

Improving customerprofitability

Improving the measurement and manage-ment of customer profitabilityABC and customer profitability analysis pro-vide the basis for managerial decision makingand actions. The information available fromthese analyses can be utilised to further cor-porate goals and strategies and maintainprofitability. An important outcome of cus-tomer profitability analysis is the understand-ing of how to better manage customer prof-itability. The success of profitability systemscan be measured as much by the awarenessthey raise as by the decisions they directlyimpact. Thus, in addition to the substantialbenefit of directly increasing customer andcorporate profitability, the process of analy-sis, discussion, and understanding of the dri-vers of customer-related costs can motivateemployees to improve their own perfor-mance and their customer relationships.

The examples of Kanthal, Co-operative Bank,and Mahany Welding Supply illustrate howABC can provide information to support theimplementation of strategic and tacticalchanges in organisations. In these cases theABC analysis provided improved informationon the wide variation in the profitability of

individual customers. This infor-mation and analysis facilitatedstrategic and tactical decisionsregarding whether to ‘fire’ unprof-itable customers or to change thepricing structures, customer ser-vice, and customer behaviour toimprove individual customerprofitability.

An ABC analysis of the unprof-itable customers is just as impor-tant as that of the profitable ones.The fixed costs of unprofitable and‘fired’ customers often remain afterthe customers have departed. Thecontribution margin will thus needto be allocated and absorbed by theremaining customers. Companiesmust then analyse the change inprojected operating expenses ascustomers are added and deleted(see Figure 15, left). The analysis of

FIGURE 15 COMPANY PROFITABILITY BY EMPLOYEE

Old methodSalesProduct costService costsProfitProfit %

Activity-based analysisSalesProduct costService costsProfitProfit %

Customer A$79,320(50,000)(16,100)$13,220

17%

Customer A$79,320(50,000)(10,510)$18,810

24%

Customer B$79,320(50,000)(16,100)$13,220

17%

Customer B$79,320(50,000)(30,093)

(773)Negative

Source: Krupnicki and Tyson 1997: 44.

27



continuing fixed customer-related costs ofteninfluences decisions regarding investments incustomer relationships and attempts to con-vert unprofitable relationships into ones thatare healthy and profitable for both the cus-tomers and the company. Before an unprof-itable customer is permitted to depart, allavenues should be explored to turn the cus-tomer into a profitable one, including anassessment of the ‘word of mouth’ conse-quences. In addition, management shouldconsider the lifetime value of a customer,cross-selling opportunities, and both theshort-term and long-term profitability.Finally good judgment by management andother qualitative information should beincluded in any decision to “fire” unprof-itable customers.

Customer profitability measures often revealthat some newly acquired customers, areunprofitable due to large customer acquisi-tion costs. In early periods, this cost has notyet been covered by the margins earnedthrough selling products and services to thecustomers. In these cases lifetime profitabilityanalysis becomes the basis for retaining thesecustomers. Customers that are unprofitablein the short-run often become very profitableas their purchases increase and their cost toservice decreases.

Likewise, customers that are unprofitable inthe long-term may require immediate actionto turn them towards profitability. This mayinclude promoting more cross-selling oppor-tunities to broaden the product range of cus-tomer purchases. Finally, other customersmay be prestigious to retain, even if they areunprofitable, since they may add reputationand credibility to the company and improvethe ability to sell to others.

Much of the customer profitability analysishas focused primarily on one type of productor service for an individual or group of cus-tomers. ABC customer profitability analysis isincreasingly flexible and forward looking,and can incorporate a wide amount of vari-ability. ABC analysis proposes to:

■ cut across the entire value chain;■ focus on multiple rather than single trans-

actions of a customer;■ focus on multiple products bought by a

single customer;

■ accumulate costs related to a customerrather than to a specific product or service;and

■ structure the analysis to be narrow in focusor broad to include all customers (Foster,Gupta and Sjoblom, 1996:10).

It is the variability and adaptability of ABCimplementations that makes them veryattractive to companies. The use of ABC willrapidly increase as information technologycontinues to make vast amounts of data andinformation readily available to manage-ment.

Information technologyJust as Kanthal improved both customerprofitability and customer satisfaction byproviding computer terminals to customers,many other companies are realising thatinformation technology can produce signifi-cant improvements. Monumental advancesin information technology are providingmanagers with improved quantity and quali-ty of information concerning customer prof-itability. Previously, management had notbeen able to track which customers were

profitable and which were not. Developingcustomer profitability databases hasimproved decision-making regarding the costof new customers and the cost of keepingexisting customers. Customer retention ratescan also be analysed to provide managementwith information about whether it is theprofitable or the unprofitable customers thatare being retained.

Earlier this guideline provided examples ofbanks and other service companies that havedeveloped sophisticated customer informa-tion and profitability systems. These databas-es can instantly provide information aboutthe profitability of an individual customer or

Developing customer databases hasimproved decision-making regarding the cost of keeping existing customers

28



a customer segment. Using this informationsome service companies encourage unprof-itable customers to leave by raising prices ontheir services to very high levels. The infor-mation is also used to develop marketingstrategies to attract the proper profile andmix of customers in the future. Companiescan then develop advertising programs toattract customers that will purchase the ser-vices within minimum costs and maximisecustomer profitability.

Banks have been at the forefront in utilisingthis new information technology. About halfof banks with more than $1 billion indeposits use profit data to make customerdecisions. These firms spent $500 million oncomputer technology and software, and it isexpected that banks will continue to spend$500 million per year in the near future asmore of them see the need for this informa-tion. To a bank, the difference in profitabilitybetween a good and bad customer can besubstantial, as determined by the account bal-ance and the amount of services and interac-tions with bank employees that the customerdemands. According to an Atlanta bank con-sulting firm, the top 20% of typical bank cus-tomers produce as much as 150% of overallprofit, while the bottom 20% of these cus-tomers drain about 50% from bank profit

(Brooks 1999:A12). Similar results were seenin the other examples cited earlier includingKanthal.

Customer profitability models can bedesigned for any type of business and for dif-ferent customer characteristics. Data can beaggregated by size of customer, size of order,complexity of service, post-sale requirements,delivery distance, etc. The information tech-nology is currently available to providedetailed information and analysis on individ-ual customers or groups of customers. FirstUnion and many of the other banks dis-cussed here have developed profitability mod-els from their large databases. Customer ser-vice representatives can then obtain instantcustomer profitability rankings from the com-puter.

A problem can arise from reliance on cus-tomer profitability profiles that focus on asingle transaction type or on a single transac-tion period. Some customers may be unprof-itable for a particular time period, and highlyprofitable for another. Further, customersmay be profitable on some company productsand services, and unprofitable on others.

The success of customer profitability analysisdepends on the information reaching those

29



who make and influence decisions. Thoughthe modelling and raw profitability data areimportant, a user-friendly, multi-dimensionalon line analytical processing (OLAP) interfaceis equally necessary. In addition to the properdata delivery device, training in the interpre-tation of the customer profitability informa-tion is critical.

Barriers to implementationPeople often feel threatened by change, donot understand it, and are opposed to itwithin a company. Commission salespersonswill try to protect customers even thoughthey may not be profitable to the company.At Kanthal, there was a genuine concern forretaining customers and trying to improvethe profitability of unprofitable ones. Sharingcost and profit information with the cus-tomer can produce a better relationshipbetween customer and supplier; when a cus-tomer has a better understanding of the priceand profitability structure of the supplier andthe reason for the price increases, there isoften a change in customer service demandsand costs.4

Customer profitability analysis can be a largeundertaking for an organisation in terms ofthe resources used and the costs to completethe initiative. Barriers to implementation caninclude:

■ convincing management that potentialorganisational improvements justify theresource allocation;

■ obtaining the significant required resourcesthat include information technology,equipment, and staff for analysis andpreparation;

■ changing the sales incentive system toreward customer profitability rather thansales volume;

■ obtaining buy-in from employees withinthe company who are often reluctant tochange; and

■ training employees in the use of customerprofitability analysis and its measurementand rewards.

At Kanthal, the salespersons felt threatenedwith the new emphasis on bigger orders,more profitable orders and orders for stockeditems only. The employees were previouslyrewarded based on volume, had been indif-ferent to ordering patterns, and had no inter-

est in individual customer profitability.Subsequently, the salespersons were urged toraise prices through surcharges and handlingcharges for small, customised orders. In thenear term, sales increased 20% with anemployment reduction of 1%, overall corpo-rate profitability increased.

However, management must be sensitive torequired change within the organisation andbe sure that employees are included in thedecision and change processes. Sears did anexcellent job of change implementation.While the new Sears vision began with top

management, the implementation of thechanges began with changing employee atti-tudes, obtaining employee buy-in, andincreasing training costs for new and existingemployees.

After Co-operative Bank obtained thedetailed information on customer and prod-uct profitability there was some resistance tochange and management needed to addresssome strategic issues. Should the bank dis-courage unprofitable customers by chargingthem higher fees? Should the bank phase outunprofitable products such as IndependentFinancial Advice/Insurance?

The Co-operative Bank was faced with anadditional conflict. Founded more than 100years ago, the bank had a history of commit-ment to individuals, the community, and thecooperative movement. The guiding princi-ple of the cooperative was that it “shouldexist for the benefit of the people it served,sharing its profits among them in proportionto their purchases.” (Datar and Kaplan1995:1) The bank reinforced these beliefswith a Mission and Ethical Statement in1988. The values, culture and mission of Co-operative Bank constrained the decisions itmade; in trying to decide whether to ‘fire’

The success of customer profitabilityanalysis depends on the informationreaching those who make and influence decisions

30



unprofitable customers, the bank was limitedby the mission statement. As a result thebank continued to work with these customersto convert them into profitable ones.

With the new information about the prof-itability of customers, the bank faced somecore value decisions. Should it discourageunprofitable customers? Should it chargeprofitable and unprofitable customers differ-ently? What effect should its Mission

Statement of ethical values and its belief inthe principles of cooperation have on its deci-sion to implement change that affects thecustomers? Clearly the bank had conflictsbetween its economic goal of profitabilityand increasing shareholder value, and itssocial goals and commitments to the cooper-ative movement. However, with the newinformation on the profitability of bothproducts and customers, more informeddecisions could be made.

Conclusion

The development of ABC in the 1980s promptedmanagers to look more closely at the causes ofcosts. More recently, increased business pressure tobecome ‘customer-focused’ and oriented toward‘shareholder value’ has increased the use of activi-ty-based costing to better understand product, cus-tomer, and corporate profitability.

Similarly, the development of the balanced score-card in the 1990s has prompted managers to look atthe causes (or drivers) of profits and success.Through a careful identification and articulation ofstrategy, the development of key success factors, andthe development of key performance indicators, thebalanced scorecard has helped companies imple-ment strategies and translate strategy into action.

Both of these models – ABC and the balancedscorecard – rely on an improved understanding ofthe drivers of value in organisations, including aspecification of leading and lagging indicators ofperformance, the relationships between them andtheir measurement. The models rely on theidentification, measurement, and understanding ofthe drivers and causal relationships of employeesatisfaction, customer satisfaction, customerprofitability and corporate profitability. Only with

the specification and measurement of theserelationships can the costs and revenues relatedto improving corporate performance be properlymanaged. The goal of business is not to improveemployee or customer satisfaction at any cost, butrather to manage those relationships to improvelong-term corporate profitability. Managers needto understand these relationships and the driversof customer profitability so they can bettermanage and improve corporate performance.

Managers must constantly make decisions thatinvolve trade-offs. They need to determine howmuch to invest in human resources and in cus-tomers. To make these decisions they need toanalyse the returns that are likely from thoseinvestments, the costs of those investments, andthe managerial incentives in place to make thoseinvestments. This guideline offers an improvedunderstanding of the analysis of customer prof-itability in order to assist managers in the alloca-tion of corporate resources.

Measuring customer profitability and understand-ing the drivers of customer and corporate valuecan lead to the improvement of overall corporateperformance.

1. For more information on ABC, see Society of Management Accountants ofCanada, The 1995b, revised 1999 (ref: Bibliography, below).

2. The examples in the first part of this guideline are drawn primarily from Judge1998; Brooks 1999; and Foster, Gupta and Sjoblom 1996.

3. For further discussion of the components and measurement of customer valuesee Society of Management Accountants of Canada, The 1995a, revised 1999 (ref: Bibliography, below).

4. See also, Society of Management Accountants of Canada, The. 1995, revised1999. Managing the Human Aspects of Organisational Change. ManagementAccounting Guideline. Mississauga, ON: The Society of ManagementAccountants of Canada. (This paper was also published as Good PracticeGuideline No 35 by the ICAEW’s Faculty of Finance and Management inSeptember 2001 – Managing Change – the Human Aspects).

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ENDNOTES

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Cokins, Gary, Alan Stratton, and Jack Helbling. 1993. An ABC Manager’s Primer.Montvale, NJ: Institute of Management Accountants.

Cooper, Robin. 1992. How activity-based cost systems help managers implementnew strategic directions. Advances in Management Accounting (Volume 1): 81-95.

Cooper, Robin, and Robert S. Kaplan. 1991. Profit priorities from activity-basedcosting. Harvard Business Review (May-June): 130-135.

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Datar, Srikant, and Kaplan, Robert S. 1995. The Co-Operative Bank. (HarvardBusiness School Case, # 9): 195-196

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Rucci, Anthony J., Steven P. Kirn, and Richard T. Quinn. 1998. The employee-cus-tomer-profit chain at Sears. Harvard Business Review (January-February): 82-97.

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Issue Title Date 1: Budgeting ✝ ❑ April 19932: Treasury Management ✝ ❑ May 1993 3: Business Recovery ✝ July 19934: Withdrawn 5: Management Information ❑ December 19936: Business Valuations April 19947: Working Capital ❑ May 1994 8: Selling a Business ❑ October 19949: Developing Performance Indicators ❑ ▲ May 1995

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