How To Do a Simple Customer Profitability Analysis

Regardless of how big your agency is, your resources will always be limited, be it cash or manpower. So, sooner or later, you will find yourself having a wide range of customers, which is a nice thing to have.

Or is it a problem?

Bear with us for a moment. No, having a large and varied customer base is never an issue, but not all customers are created equal. Some generate more revenue for you than others, and others cost you more through additional requests and services.

Knowing where you stand with each of your customers in terms of revenue and costs would certainly help you determine which customers are the most valuable to your business, and customer profitability analysis is the right tool for the job. Let’s look into what it is, why it matters, and how to conduct it.

What Is a Customer Profitability Analysis?

Custom profitability analysis (CPA) compares how profitable your clients or customers are by looking at each one individually. In other words, it’s a measure of how financially valuable a customer, or a customer segment, is to your business.

Similar to cost-benefit analysis, It’s not just a process or mere number crunching, but a strategic approach helps you identify the main drivers behind your revenue. By focusing on the most profitable customer segments, you can make better operational and financial decisions.

Now, there is more than one way to calculate customer profitability, and the way you’re going to go about it depends on your industry. For instance, if you are in the business of manufacturing goods, then you would look at the revenue generated per customer and compare it to the operational costs, which include labor and materials, as well as additional costs, such as inventory and shipping.

If you are running an agency, which is the focus of this article, you should consider looking at the revenue you are getting from each client and compare it to the cost of services you provide for them. Including billable hours and overhead costs.

Why Measuring Customer Profitability Matters

Although the obvious answer is that it helps you determine the profitable customers, there are actually additional benefits to it, including:

• Identifying profitable and non-profitable customers: By determining which customers impact your bottom line the most, you can focus your efforts and resources on them in order to boost your profit margins. On the other hand, you can also determine which customers are holding you back, which helps you cut the costs down.
• Improving customer retention: Your agency can turn toward providing premium services to high-profit customers. Sometimes, it may even include spending more in order to earn more from those clients.
• Cost management: For example, some clients may cost you more than others, and identifying them can help you understand how your money is being spent, as well as adopt cost-saving measures.
• Informing your marketing strategy: Doing a customer profitability analysis enables you to zoom in on the most profitable customer segments, so that you can create marketing campaigns targeting that particular segment and improve your ROI as a result.
• Making strategic decisions: By eliminating the amount of guesswork when it comes to your finances, your agency will be able to make better decisions. For example, you can allocate your resources toward developing customer loyalty within a high-earner base.

How To Calculate Customer Profitability: A Step-by-Step Guide

The formula, as we have mentioned before, is fairly simple:

Customer Profitability = Total Revenue Generated by Customer - Cost to Acquire/Serve

Given that you don’t change the price of your services too often and that you only charge so many hours, the biggest factor in this equation is the service cost associated with a particular customer or a group of customers.

Ask yourself these questions:

For example, if your marketing agency is providing copy and content for one of your customers, are they asking for edits all the time? Are charging for those edits or are they free?

If you have clients like these, performing a customer profitability analysis will tell you if they are making you lose money in the process and if you would be better off cutting ties with them.

With that being said, let’s take a look at the actual steps you need to take to conduct a customer profitability analysis:

Identify Your Communication Channels and Customer Acquisition Cost

The first step in your customer profitability analysis should be to write down all the channels through which your customers can reach out to your agency.

Once you identify all the different points of contact through which customers can interact with your agency, you can get a better understanding of them and figure out both the visible and implicit costs of those channels.

Consider how much it costs your agency to serve or acquire customers via those channels. Make sure to take note of the marketing, social media, and sale costs involved. Once you have a firm grasp on those, it’s time to move on to the next step.

Collect Data and Establish Profitability Metrics

Gathering data is arguably the most crucial step in your customer profitability analysis, as it enables you to collect insights on your customers and determine the main cost drivers, which are factors that play a major role in your operational costs.

If you are running a marketing agency, these include both operational costs, which are your salaries, bonuses, and money you invest into employee training and development, and indirect costs, which are things like software licenses, subscriptions, and rent.

Then, you will need to determine which customer profitability metrics to consider, as they can hold hidden bits of data that can shed light on additional costs. For instance, identifying the average marketing costs to generate an order or the average cost per customer service contact are such metrics.

Calculate Costs and Profit Margins

After you have identified your main cost drivers and metrics, you will need to assign them to your individual customers in order to determine how much they cost you. This includes figuring out all the costs of getting your service to them.

Calculating the direct expenses for every customer is fairly simple, especially with ActiveCollab, which provides you with a clear overview of how much time your team members have spent on each client.

General expenses should be calculated as well, and then assigned to each client proportionately.

Before going any further, you will have to determine a healthy profit margin, which will depend entirely on your industry. Generally speaking, 10% is considered a healthy margin, but in the case of marketing agencies, a healthy profit margin might be as high as 20% or more.

Segment Your Customers

Next up is segmenting your customers. You can segment your customers based on a number of factors, such as industry, customer behavior, interests, or demographics, just to name a few.

Since you are looking into customer profitability, you can also segment them by:

As a marketing agency, this approach can help you determine key accounts which require customized services and dedicated resources, but which also bring in the most revenue, as well as smaller clients, that require standardized services and solutions.

That way, you can zero in on the most profitable segments and tailor your strategy to those that need more of your attention.

Take Action

Once you have all the data you need and all of your customers segmented and analyzed, it’s time to start making changes to your approach. This means:

• Altering your services: In other words, customizing them to fit the needs and interests of the most profitable customer segment.
• Optimizing costs: Reducing the costs for your least profitable customers by standardizing your services or shifting focus from those customers altogether.
• Improving customer experience and retention: In order to keep your high-value customer segment, you can introduce perks, incentives, and loyalty programs.

Benefits of Measuring Customer Profitability

So far, you’ve probably been able to see some of the benefits that the customer profitability analysis can bring. Here are some additional ones you might not have picked up on:

Focusing on the Right Market Segment

By being able to identify the most profitable markets, you can come up with new strategies or adjust your existing ones in order to reach more high-value customers.

And if you still don’t want to give up the lower-earning segment because there is potential there, you can find a way to reduce costs. This is a good approach if you want to retain your presence in price-sensitive markets.

Better Customer Experience

Targeting the right customer segment also means that your messaging, service offerings, and sales processes will be more aligned with what your customers need, which results in a much more satisfying customer experience.

When you deliver exactly what your customers need and how they need it, you can rest assured that they will be much happier and willing to stick around.

Data Insights

Customer profitability not only enables you to uncover an entire goldmine of data and insights but also spot profitability trends across each of the customer segments, service offerings, seasons, and any other category that factors into your overall strategy.

Plus, you eliminate the amount of guesswork, and make the most of your marketing dollars.

Minimizing Cost Factors

Once you identify the cost factors related to each market segment, you can make a more informed decision about your strategies for reducing those cost factors. In other words, you can decide to restructure your services by cutting costs and offering a more lean service for your less profitable customers.

Or you can opt out of that segment altogether, and direct your efforts toward high-value key accounts.

Challenges of Measuring Customer Profitability

While CPA does shine a light on a number of crucial insights, it’s not without its challenges. These include:

Getting Accurate Real-Time Data

Gathering real-time data in one place and making sense of it is a challenge, especially if you are not using a centralized PSA or project management platform to do it. And a lot of agencies don’t.

With ActiveCollab, you can gather insights for each of your customers, each customer segment, and your expenses.

Overservicing Your Clients

Saying no to your clients is a big challenge because you don’t want to risk them jumping ship or developing a bad reputation. But let’s face it, some clients are more difficult and demanding that others, and they end up eating into your profit margin.

The key is to keep your communication clear and transparent so that your clients are aware of your actual capabilities.

How ActiveCollab Can Help You Track Customer Profitability

With ActiveCollab, keeping an eye on how much revenue each of your clients brings, as well as how much you’ve spent on them is a very streamlined process.

With its time-tracking functionality, you are never more than a click away from knowing how much you’ve spent on each customer, and that includes non-billable hours as well, such as the time you spend on the client site or in meetings.

Aside from keeping all of your client-related time records in an accessible and user-friendly manner, ActiveCollab can also give you a detailed breakdown of how much revenue each customer or customer segment brings in.

For this, you can make use of its powerful Reporting and Invoice features.

Conclusion - Identify Your Top Clients with ActiveCollab

All of the benefits and challenges aside, customer profitability analysis is a powerful tool for identifying how much each of your customers earns your agency, as well as the hidden costs related to each customer.

Once you have all this data at your disposal, you can make better decisions, tailor your services to the right customers, reduce costs, and improve customer satisfaction and experience.

And with ActiveCollab as your ally, you don’t have to dig through Excel spreadsheets or whip out a calculator. You will have everything you need at your fingertips.

Ready to discover who your key accounts are? ActiveCollab is the perfect tool for the job!