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Measuring Customer Profitability

How does a business measure the profitability of their customers? It’s not easy. You can look at what they just bought and compare the revenue from that sale to what your cost was to make that sale, resulting in your profit. Or you could consider what long term value that customer will have with you and compare that revenue with the costs associated with keeping them as a client. Or you could simply guess (although I must advise against this method). However you do it, it’s important for a business to understand how profitable their customers are, and plan their sales and marketing efforts around that critical customer information. After all, you do need to generate a healthy ROI for your business to survive and thrive, and every customer is not worth keeping.

Color My World

A very simple way to track profitability is to color code each client. Whether your client list is managed by using a spreadsheet (Yuck! The thought!), or by using a CRM product (highly advisable), you can assign a color code to each client’s profitability level, or even just a letter or number code. By doing so, you can select out those that are most profitable and prioritize your marketing and sales activities and resources around their needs. The lower the profitability index (color, letter, number) the fewer resources, energy, time, money, etc. should you spend on that client. By managing your spending more wisely it will allow you to provide your valued customers with what they need while giving you a better return on your investments.

You can do what the airlines do by assigning service tiers based on usage. The more miles you fly, the better service tier you are in and, hence, the more perks you earn. This has the affect of keeping customers longer, since they want to collect all those points to redeem for free stuff (e.g., a flight to see Mom on her birthday). However, don’t confuse longevity with profitability because this approach could backfire. Your client could simply be staying with you because they figured out how to work your system, but end up generating small profits for you.

Best Buy learned this the hard way. Many of their so called “long-term” customers figured out that they can buy products, apply for rebates, return the purchases, then buy them back at return-merchandise discounts. Or, they’d load up on severely discounted merchandise designed to boost store traffic, then sell the goods at profit on eBay. Or, they slapped down rock-bottom price quotes they found on the Web and demanded that Best Buy make good on its lowest-price guarantee. So Best Buy ended up changing many of their policies, such as charging a re-stocking fee for returned items and cutting back on promotions and sales tactics that tend to draw in these unprofitable customers. They also started stocking more merchandise and providing more appealing services directed at their more profitable customers.

The Balancing Act

When focusing on your profitable customers, you want to avoid assigning fixed-costs to the resources you apply to develop their loyalty. Fixed-costs tend to map to your company’s choices, not the customers’. So you may miss out on delivering the types of services your customers want and need. Your costs may vary depending on the customer type, the loyalty program, or the amount of profitability of each client. Likewise, marketing expenses also skew your measurements since many marketing campaigns reach out to unprofitable customers (for help with calculating how many leads are needed for your campaign and how to measure the results of your campaign, click on to download a free Marketing Program Investment Calculator).

Once you’ve analyzed your clients’ purchasing history (amount purchased, costs, profits, frequency, volume, etc.) to determine their profitability, you can measure the “value” of each customer. When their value is established you can assign, or un-assign, resources accordingly. There is a careful balancing act you have to play here since you should try to apply just the right amount of resources to get the best return on your investment. Apply too many resources to an unprofitable client, and you’ve wasted money. Apply too few resources to a valued client, and you risk losing them.

More importantly, the balancing act has to be played with the different types of profitable customers. Customers with a high present value (just made a large purchase from you) are not the same as those with a high future potential (they’ll keep buying from you over time). It takes more than just measuring their worth by the number of products you just sold them or the amount of revenue generated from one sale. It’s more about the customer’s Life-Time Value (LTV).

Many businesses don’t spend enough time and energy developing customer retention strategies to build loyalty and long-term relationships after the sale. As a result, they make a single purchase and never hear from the client again. Typically, that’s because the client never heard from them after the sale either. The effect of customer retention can be dramatic. Just a small increase in retention can make a huge difference in your bottom line. However, you have to make sure you are retaining the right, profitable customers.

Tracking the profitability of your customers will help you better manage your business while improving your customer retention. It requires understanding who your more profitable customers are so you can pay more attention to satisfying their needs. It also requires knowing who your unprofitable customers are so you don’t waste valuable time and resources on non-revenue generating activities. Measure profitability, adjust accordingly, improve your ROI, and keep your good customers coming back for more.

About the author:
Russ Lombardo, President & Founder of PEAK Sales Consulting, is a nationally recognized Sales and CRM consultant, speaker, trainer, and author. Russ works with sales organizations and management who want to increase their sales results by acquiring new customers and retaining existing ones. As a speaker, Russ presents sales training seminars and customer retention workshops as well as keynote and conference speeches to dozens of audiences every year. He is the author of five books on Sales and CRM.


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