Management accounting - Customer profitabilty analysis & customer portfolio

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1. Introduction

The marketing concept and customer centric approach has been recognised in the marketing literature for many years (Bell and Emory 1971; Jobber and Ellis-Chadwick 2012), but it was not until around the 1990s that the importance of customers, or more significantly customer profitability analysis (CPA), began to appear in the accounting literature (Bellis-Jones 1989; Cooper and Kaplan 1991; Ward 1992; Foster et al. 1996; Hoque 2003). Metrics associated with the customer perspective were promoted in the balanced scorecard (Kaplan and Norton 1992, 1996), and the use of activity-based costing was linked with CPA (Kaplan and Cooper 1998), but despite the use of the words profitability and costing, McManus and Guilding found in their 2008 review of the accounting and marketing literature that coverage in the accounting journals was little more than fledgling. This is still true today in that coverage in mainstream accounting journals is relatively sparse compared to the marketing literature. Thralls (2008) provocatively suggests that CPA is not seen as mission critical and consequently is not viewed as a high-profile technique. It is, however, frequently described as a strategic management accounting (SMA) technique (for example in Guilding et al. 2000; Cadez et al. 2005; Cinquini and Tenucci 2007). Perhaps the difficulty that supporters of SMA have experienced in establishing the term within the accounting lexicon (see for example Langfield-Smith 2008; Nixon et al. 2011; Nixon and Burns 2012), may have detracted from the discussion of specific techniques such as CPA. The fact, however, that customers yield different levels of profit, and that some customers are unprofitable, is widely accepted. Indeed, some studies have identified that 20% of customers can generate as much as 225% of total profits (Cooper and Kaplan 1991) or that 60% of customers can generate two to three times the total profit, with the remaining customers consuming considerably more resources than revenue they generate (Cokins et al. 1993). This is often represented in the literature as the ‘whale curve’ (Kaplan and Narayanan 2001), or as an ‘inverted Lorentz curve’ (Mulhern 1999) or ‘Stobachoff’ curve (Storbacka 1998). A curve created by progressively adding the profits generated by each customer from the most profitable to the least profitable (see Figure 1 in full article). 

    Understanding the relative profitability of customers allows management to act to improve the overall profitability of the company (van Raaij 2005). It is not, however, just a case of dropping the unprofitable customers. In some regulated industries this may not be an option. Therefore, managers need to find ways of improving profitability, for example, by developing new products specifically for low spend segments or changing purchasing behaviour (McManus 2007). Cooper and Kaplan (1987) highlighted that new and growing customers may be unprofitable initially, but then become profitable as the relationship develops.  It is also suggested by Epstien et al. (2008) that unprofitable customers may have hidden value such as influence or knowledge, a phenomenon that Horngren et al. (2000) refer to as unexpected revenue generation. 

    By utilising CPA van Raaij et al. (2003) point out that managers can identify opportunities in strategic marketing management, revenue generation and cost management activities. According to Kumar et al. (2004) CPA can aid managers to develop relationship-marketing strategies targeted at the most profitable customers, and as part of a customer relationship management system attempt to influence customer behaviour, customer acquisition, retention, satisfaction and hence overall profitability (Swift 2001; Ngair 2005; Boulding et al. 2005). The objective of the strategies adopted would be to lift the whole whale curve, but also to flatten the curve after it begins to dip. 

    Previous studies of CPA have been adequately explored in the existing literature with the reviews by McManus and Guilding (2008), Bates and Whittington (2009), and Roslender and Hart (2010) providing good coverage of the literature, so the intention in section two is not to provide a comprehensive review of the literature, although a degree of review is inevitable, but to set the context and the theoretical background for the example case studies of CPA provided on this site. The case studies provided highlight the strategic benefits that can be gained by accountants and marketers working together to understand relative customer profitability. They demonstrate that CPA cannot be used effectively in isolation but adds the most value when viewed as part of customer relationship management and customer portfolio management.