Some of Your Best Customers Are Costing You Money
Revenue by customer is easy to produce and tells you very little. Profit by customer, once service costs are attributed properly, usually reveals that a minority of accounts carry the whole business.
Revenue Is Not Contribution
Most companies can rank customers by revenue instantly and rank them by profit only with difficulty. That asymmetry matters, because the two rankings are frequently very different, and commercial decisions get made on the one that is easy to produce.
Customer profitability analysis attributes not just product cost but cost to serve down to individual accounts, then asks what each one actually contributes.
What Cost to Serve Includes
Two customers buying identical volumes of an identical product can consume wildly different amounts of company resource.
| Cost to serve driver | High cost customer | Low cost customer |
|---|---|---|
| Order pattern | Frequent small orders | Few large orders |
| Customisation | Bespoke specification | Standard product |
| Delivery | Expedited, split shipments | Scheduled, consolidated |
| Support | Heavy technical contact | Self serve |
| Payment | Slow, disputes invoices | On terms |
| Returns | High rate | Minimal |
None of these appear in gross margin. All of them consume real money. A customer generating strong gross margin and heavy service demands can be a net loss, while a smaller undemanding account is quietly profitable.
Gross margin measures the product. Cost to serve measures the relationship. Only the two together tell you whether a customer is worth having.
The Distribution Nobody Expects
When companies build this analysis for the first time, the result tends to follow a consistent and striking shape. A minority of customers generate substantially more than total company profit. A middle group roughly breaks even. And a tail of customers destroys a meaningful share of the profit the top group created.
The specific proportions vary by industry, but the qualitative finding is remarkably robust: total profit is the net of a large positive and a large negative, not the sum of many small positives. Companies that have never looked assume the third group does not exist.
Firing Customers, and Why It Usually Is Not the Answer
The obvious response to an unprofitable account is to end the relationship. It is rarely the best first move, for the same reason that closing an allocated loss making division is rarely right: much of the cost attributed to the customer does not disappear when the customer does.
If a customer covers its avoidable costs and contributes anything toward fixed overhead, removing it makes the company worse off in the short run, even though the allocated report shows a loss.
The better sequence is to attempt repair first.
Change the terms. Minimum order sizes, charges for expedited delivery, fees for customisation. Much unprofitable behaviour exists because it is free to the customer.
Change the service model. Move small accounts to lower cost channels rather than field sales coverage they do not justify.
Reprice. If the customer genuinely needs the service intensity, the price should reflect it.
Many unprofitable customers become profitable after this, because the behaviour driving the cost was a response to incentives the supplier set.
The Trap in the Analysis
Customer profitability is vulnerable to the same allocation error as divisional reporting. If shared overhead is spread across accounts on revenue, large customers absorb large charges and appear unprofitable for reasons that have nothing to do with how they behave.
The analysis is only useful when it attributes costs that are genuinely caused by the customer. A charge that would exist whether or not the account did belongs in an unallocated line, not in the customer margin.
The Bottom Line
Ranking customers by revenue hides the fact that service costs vary far more between accounts than product costs do. A rigorous cost to serve analysis usually finds that profit is concentrated in a minority of relationships and eroded by a tail that no one had identified. The productive response is to change terms, service models and prices so that the behaviour driving the cost becomes something the customer pays for, and to reserve exit for the accounts that fail even that test.