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Summary
At some point, all successful businesses realize that attaining greater profitability is not simply a matter of increasing revenue or cutting costs willy-nilly. A key insight is that certain customers are more profitable than others. Adding an unprofitable one will be counterproductive, as will stinting on extras that reduce costs but drive away lucrative clients. Improving profitability is a key objective of performance management efforts, through a combination of targeting revenue gains from the right sources (usually by enhancing the effectiveness of process execution to focus on more than just revenue) and through improved efficiency by eliminating costs that are not needed to satisfy customers. We advise senior executives to make customer profitability performance management an ongoing discipline, particularly in the finance organization. Information technology will be a critical component of any customer profitability effort, but executives also must manage strategic, organizational and analytical issues. If done right, the payoff from these efforts will be evident on the bottom line.

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Improving customer profitability is not a new idea. Good managers have always looked for ways to achieve the highest possible margins. However, companies rarely approach improving customer profitability in a systematic or strategic fashion, and individual efforts to improve returns in one’s own bailiwick may be counterproductive for the enterprise (for example, extending warranties to boost sales without considering support costs). Moreover, many of the analytic techniques and tools necessary to achieve sustainable results have been available in easily usable form for only a few years, and management techniques to apply them properly continue to lag.

In the 1990s technologists and vendors promoted business intelligence (BI) and customer relationship management (CRM) software as ways to improve customer profitability. BI advocates asserted that combining information held in disparate operational and financial systems would provide answers to critical questions. CRM proponents argued that having a centralized view of the customer would provide the knowledge and insight required to achieve performance breakthroughs. Some insisted that using the data in these systems would allow companies to intelligently segment customers and prospects and tailor offerings for each of them. Yet few of these efforts produced the desired results. Simply having the right information is only the first step (albeit a critical one) in really improving customer profitability. Accomplishing it also requires organizational discipline and experience to analyze this information properly in the company’s strategic context and to organize the initiative appropriately.

Ventana Research believes that companies must develop a focused, consistent approach to managing customer profitability. It should incorporate the following four essential elements:

Strategy – What is the corporation’s strategy for customer profitability? Which options are best suited to implementing this strategy? For example, a company pursuing a “fashion leader” strategy will likely take a very different approach than one focusing on keeping costs low.

Analytics – Understanding the true bottom line from individual customers or classes of customer can be the single biggest challenge to a profitability program. Traditional accounting-based measures of profitability often mask the real returns. Developing frameworks and the details of this analysis must be a priority. In some cases the most appropriate metric may be a simple analysis of the contribution margin on a single transaction; others may require a more involved set of data on various costs over customers’ life cycles.

Information Technology – Is the data necessary to assess profitability readily available and updatable on a timely basis? How should it be collected and stored? Many companies have most of the information they need to manage customer profitability, but not all of it. And some of the information may not be accessible to the right people. But while reengineering the IT architecture to address this challenge, it is important to avoid complicating data collection to the point that it becomes a roadblock. Those driving the initiative need to have basic tools for understanding IT requirements and yardsticks for assessing alternatives.

Implementation – In applying its customer profitability strategy, every company will face different issues. As a rule, narrowly focused customer profitability projects are easier to put into place. However, they must be designed and executed from a corporate rather than business unit perspective; otherwise they can fail to enhance overall performance (because they don’t consider all costs) or will not confer long-term competitive benefits (because they are inconsistent with the company’s strategy).

Assessment
Ventana Research believes effective management of customer profitability will be an important differentiator of corporate performance over the next three years. We advise companies to address customer profitability at a corporate level instead of allowing business units to manage initiatives on their own. In our judgment, finance organizations must take the lead in shaping, organizing and coordinating these efforts because they can give initiatives attention at a senior level and because they control the resources required for analysis and implementation. Moreover, in the organizational tug-of-war that usually accompanies any such effort, Finance is a neutral party.

Information technology will be a key component to the success of customer profitability initiatives. Using the right technology enables corporations to gain important insights into what affects margins and allows them to measure how well the initiatives are paying off. Yet IT is just one important factor that companies need to manage, along with the analytic techniques and executive leadership needed to bring such a cross-functional effort to fruition.