Nowadays, every business is rushing to generate more traffic and increase leads. Sometimes, they market aggressively through paid ads; other times, they direct traffic through link building.
Even though these strategies prove beneficial, some unprofitable customers work their way into the company. They exhaust time and resources more than bringing profits, resulting in high costs. Haven’t any of your customers spent hours with sales reps to buy only one product?
These low-profit customers can significantly decrease the company’s growth and profit potential. To identify them, you have to conduct a customer profitability analysis. It will help you determine which customers are sapping your cash flow and profits.
First, you must consider each customer’s sales volume and cost margin. Likewise, calculate the average sale per transaction to find customers who drain the company’s resources.
The profitability analysis will also identify highly lucrative customers that generate millions of worth of revenues for the business. In turn, you can offer them preferential treatment and sell at a higher margin. However, if you don’t know much about this, keep reading. Below, we’ll discuss customer profitability analysis and how it benefits companies.
What is Customer Profitability Analysis (CPA)?
Lately, the CPA method has come into the limelight for all the right reasons. It determines the overall profit a customer generates, helping you recognize the lucrative clientele. However, conducting this analysis isn’t everyone’s cup of tea. It requires extensive know-how of financial metrics and ratios.
If your finance team lacks the expertise needed for calculating such financial metrics, provide them with eLearning options. You can sponsor Finance MBA Program Online for your employees and ensure they master such crucial metrics.
It will improve their analytical skills, helping them evaluate the cost of serving customers. In addition, they will understand the correlation between customer size and profitability. In most cases, the bigger the customer, the higher the profitability.
Now, you might be wondering how to calculate customer profitability? You would need annual profit per customer and the duration a customer stays with the business. For annual profit, subtract the expenses incurred with revenue generated by the customer in a year. It will give you the exact amount a customer has brought into the profit. If it seems meager, you can let the client go and look for more profitable customers.
How to do Customer Profitability Analysis?
Although the process to do this analysis is pretty simple, you have to follow a step-by-step approach.
- The foundation for a profitability analysis is customer segmentation. You can categorize customers based on demographics such as age, income, area, etc. Similarly, you can create psychographic segmentation based on customer needs and behavior.
- After this, calculate the revenue for every segment with all necessary adjustments such as discounts, service charges, etc.
- Lastly, calculate the cost per segment to determine the final cost attributable to every customer.
The next step will be creating strategies and building long-term relationships with the most profitable customers.
Benefits of CPA
By now, you have understood that CPA allows business owners to assess a customer from a profitability viewpoint. However, that’s not the only advantage of CPA. Have a look below to see what CPA has to offer your business.
1. Effective Marketing
Once you have identified the most profit-generating customer growth, use it for further acquisition. Your marketing teams can design their campaigns based on those customers’ preferences and increase conversion. Marketers can also create deals and offers based on the profitability range for prospective clients.
For instance, if some customers shop a lot but don’t like paying shipping charges, create a deal for them. Maybe, you can offer free shipping for all orders above $499. Lastly, CPA can give an estimated duration for the ROI on marketing. It means you can determine how long it will take to recover the customer acquisition cost.
2. Increases Customer Retention
Unsurprisingly, retaining an existing customer is far cheaper than acquiring a new one. Therefore, consider customizing the retention strategies. Since you have identified the lucrative groups, give the highest quality service to the most profitable clients. In simple words, spend more resources on the company’s valued customers.
Moreover, spend a few bucks on building loyalty. You can develop customer loyalty programs based on the margin for a particular customer segment. These few strategies will go a long way in improving business growth.
3. Enhances Operational Efficiency
Sometimes, the reason for low profits isn’t always the customer. Often, the lower profit customer group consumes many resources to deal with the same issue repeatedly.
Therefore, instead of allocating resources to the recurring problem, the company can resolve the issue. Perhaps, you can build a feature in the product itself that caters to the customers. In addition to decreasing the operational cost, the product will be more saleable, increasing revenue.
Entrepreneurs have to look after products, marketing, and operations in today’s bustling environment. Hence, they often forget about customers. As a result, they have to incur the expense of maintaining unprofitable customers. CPA is the perfect way to overcome this problem.
It allows companies to evaluate customers and determine the profits they generate. Accordingly, they can decide whether it is beneficial to keep the customer.