Analyst News -- Dectember 2003

Consumer goods companies are experienced in evaluating product profitability. What most of them do not understand, however, is how to assess and manage the profitability of their channel customers. Channel customer profitability reaches far beyond customer relationship management (CRM) by fusing strategy and technology to offer true business economic value. A recent Fortune magazine article puts it into perspective: "Boards of directors will soon begin to demand customer profitability data and will challenge management to act on it; investors will demand that companies report it. They will have to, because knowledge of customer profitability will enable them to attract investors away from competitors that don€™t have this knowledge. And that€™s an advantage that no company can safely ignore."

Today, individual retailers and wholesalers represent a significant share and influence over an entire corporation€™s economic viability. Understanding who is profitable, who isn€™t and why will allow executives to make fact-based decisions and enter into reinvestment discussions with those customers that will ultimately strengthen the customer relationship and impact the share value of the manufacturer. Armed with this valuable data, manufacturers will also create a "balance of power" that will be useful in collaborating with channel customers.

Cost to Serve

To truly figure out where the return on investment is within you customer structure, you must first determine the "Return on Channel Customers." Do you truly know which of your customers is most profitable? Are you confident you have the required level of detail to determine the total cost of doing business with your customers, taking intangibles into account? The answer is not as straightforward as one might think. Carefully examine all of the functions that "touch" the customer to create a holistic and realistic view so that specific actions can be taken when analysis is complete. Also, this should be a process, not just a one-time or periodic event. An automated system to continually collect detailed data will give you visibility into which activities are providing mutual economic value or mutual economic waste between you and your customers.

Stating the Obvious

Measuring customer profitability starts with looking at obvious direct costs such as trade promotional spending, but it is imperative to also use activity or process-based costing to identify costs for such things as inventory carrying costs and order processing. Activity or process-based costing breaks down the business processes into specific activities and identifies the manufacturer€™s costs of the resources and materials used for those activities. This provides consumer goods companies with a more accurate picture of the actual customer-specific costs incurred in the enterprise.

On Display

For a prime example of measuring customer profitability, look no further than display-ready pallets. Manufacturers started to provide these display cases in custom tiered pallet configurations -- made to order with display and promotional signage. Over time, cost that had once been incurred by the retailer had transferred to the manufacturer. Today, it is not necessarily seen as a competitive advantage, but instead a cost of doing business and staying on industry par. As a result of these trends, "cost to serve" a particular trade customer may vary significantly. In addition, these incremental customer investments may go unrecognized and contain hidden economic waste. (i.e. Does every display-ready pallet shipped to a customer end up on display or as regular shelf stock?)

This understanding of customer profitability and "cost to serve" is the foundation for developing a pricing strategy for your customers and channels. This analysis will identify correlation (or lack thereof) between your true cost to serve a particular customer, and the prices and trade allowances you are offering. Menu-based pricing or service-based pricing models may be developed that are compliant with the Robison-Patman Act, and economically more effective than a pricing strategy based on historical volume alone.

Examining ROI

The overall objective with a detailed "Channel Customer Profitability Analysis" is to determine which activities in the Manufacturer/Channel Customer relationship are not adding strategic or economic value (e.g., returns), and how those activities can be reduced in order to reinvest that effort in activities that do add mutual strategic or economic value (e.g., consumer promotions, brand equity building).

This deep activity based cost analysis needs to be at a "business" level of detail vs. a "financial" level of detail; thus including cost related to customer manufacturing, logistics, order management, claims and collections, sales promotions and trade marketing, returns and unsaleables, and overhead and administration. The capital investment in a sales office and equipment used to support a specific trade customer is an example of customer specific overhead costs that need to be included in the analysis.

Develop a system that will constantly provide the necessary information for immediate action to impact the bottom line. In addition, know what customers are providing return on the relationship investment as you will be in an excellent position to ensure a strong and economical relationship with the most profitable customers.