Customer profitability score

Customer delight is often treated as an unquestioned corporate objective. Yet satisfaction creates economic value only when the revenue from a relationship exceeds the complete cost of acquiring, serving and retaining that customer. The customer profitability score keeps that commercial reality visible.

When to use it

• Answer the key performance question: “To what extent are we generating profits from our customers?”
• Assess this KPI within the Customer perspective.
• Plan data collection, formula use, reporting frequency, and data-source requirements for this KPI.
• Compare results against the targets, benchmarks, examples, or trend guidance available for this KPI.

Origins

Customer-profitability analysis grew out of direct marketing, database marketing and activity-based costing. During the 1980s, activity-based costing connected overhead with the activities and cost drivers that consumed it; applying the same logic to customers revealed that accounts producing equal revenue could generate very different profits. A profitability “score” is a managerial summary of that analysis, so its contribution, service-cost, acquisition-cost and time-horizon assumptions must remain explicit.

What it is

Perspective: Customer perspective.

Key performance question: To what extent are we generating profits from our customers?

Customers must buy for an organisation to prosper, but not every sale creates value. Some customers contribute strongly to profit, while others cost more to acquire, deliver to and support than the revenue they generate.

An indiscriminate pursuit of delight can therefore become loss-making. Extra features, exceptions and service may please a customer while the supplier absorbs costs that its price never recovers.

This inequality has been documented for decades. One analysis of a US insurance company found that 15–20% of customers generated 100% or more of profit. The most profitable customers produced 130% of annual profit, the middle 55% broke even, and the least profitable 5% created losses equal to 30% of annual profit.

The score prevents customer enthusiasm from obscuring the organisation’s economic objective: earning a sustainable return from the products and services it sells.

How to use it

Measurement

Data collection method

Combine marketing and accounting records with the cost allocations produced by activity-based costing.

Formula

For a defined period, customer profitability equals the revenue earned from a relationship minus every cost attributable to that relationship. It is the customer’s net monetary contribution to the organisation.

Because customer value can be examined over different horizons, there is no single universal score. The four principal views are:

• Historical value summarises profit already earned over a period such as the previous fiscal quarter, previous year or the full relationship. A simple or time-weighted average can smooth volatility, with greater weight placed on recent performance.
• Current value examines a short period, often a month to align with reporting. It can be volatile because seasonal relationship activity may not fit inside a single month, but comparisons with prior periods quickly expose the effects of campaigns, new offers and pricing changes.
• Present value estimates the future revenue and cost streams of existing business, normally over the contractual life of current products or services. It supports customer ranking, sales compensation and pre-implementation modelling of price or service decisions.
• Customer lifetime value adds modelled revenue and cost from future business expected beyond the current relationship. It is therefore broader than present value and is also treated as a related KPI.

Time-driven activity-based costing is often used to estimate the total cost of serving a customer. It needs two inputs: the hourly cost of each resource group and the time that a specific product, service or customer activity consumes. If customer support costs $70 per hour and a transaction requires 24 minutes, or 0.4 hours, that transaction costs $28. The same logic can be scaled across hundreds of thousands of products and services and thousands of customers.

Frequency

Choose the reporting frequency to match the value perspective being used. Historical, current, present and lifetime views cover different periods and should not be treated as interchangeable.

Source of the data

Use accounting and marketing records, supplemented by time-driven activity-based costing results.

Cost/effort in collecting the data

The analysis is valuable but may be expensive when many customers and activities must be costed. Time-driven activity-based costing requires training, dedicated resources, management discipline and direct observation of how work is performed.

Target setting/benchmarks

The practical aim is to improve the economics of loss-making and break-even customers, moving viable relationships into stronger profitability categories.

Example

Consider a bank calculating profitability for individual customers.

1. Establish cost to serve. Activity-based costing estimates the cost of each interaction: mailing a statement = $1.00, calling the contact centre = $2.00 and visiting a branch = $3.00. Assume the average customer receives one statement and makes one branch visit each month, while calling every two months. Annual cost is (12 × $1.00) + (12 × $3.00) + (6 × $2.00) = $12 + $36 + $12 = $60. Segmentation, such as customers over 50 who visit branches more often, can later refine the average.
2. Establish customer profit. Suppose the bank earns 3.5% on invested deposits. Customer A deposits $1,500, so the gross contribution is:

$1,500 × 0.035 = $52.50

After the average service cost, the score is $52.50 − £60 = − $7.50: a loss of $7.50. Customer B deposits $15,000, producing:

$15,000 × 0.035 = $525.00

After the annual service cost, the score is $525.00 − $60.00 = $465, a healthy profit of $465.

Top practical tip

Interpret the score alongside the whole relationship. A customer who is unprofitable today may have a high lifetime value, while a currently profitable customer may not. Diagnose the reason and future potential before changing service or ending trade.

Top pitfall

Do not make acquisition decisions from an optimistic lifetime-value estimate alone. New customers often have volatile purchasing behaviour, and forecast profitability can differ sharply from realised economics.

Equally, do not act on one period’s negative score without checking whether onboarding costs, seasonality or a temporary service event distorted the result.

Further reading

Robert S. Kaplan, A balanced scorecard approach to measure customer profitability, 8 August 2005, Working Knowledge, Harvard Business School, http://hbswk.hbs.edu/item/4938.html