What questions might managers and employee teams ask about their customers that can be answered with detailed profitability reporting? Here are some examples:
- Do we push for volume or for margin with a specific customer?
- Are there ways to improve profitability by altering the way we package, sell deliver or generally serve different types of customers?
- Does the customer's sales volume justify the discounts, rebates or promotion structure we provide to that customer?
- Which products are relatively more profitable to cross-sell or up-sell?
- Can we realize the benefits from our changing strategies by influencing our customers to alter their behavior to buy differently (and more profitably) from us?
- Can we shift work to or from some of our suppliers based on who is more capable or already has a superior cost structure compared with ours?
Risks from Inaccurate Cost Calculations
Companies plan and control their operations using accounting information that is assumed to accurately reflect the costs of their products and standard service lines. In fact, this is often not the case. The recorded expenses, such as salaries and supplies, may be exact in their amounts because they are externally audited and automated accounting systems capture them - but the problem is then transforming those expenses into their calculated costs of the business processes and the products that, in turn, consume those process costs.
The costing systems of many companies, with their aggregated summaries and their broad averaging allocation of indirect costs, mask reality with an illusion of precision. In fact, traditional cost systems typically provide misleading information to decision-makers with minimal transparency to understand what constitutes a product's cost.
To further complicate matters, with the shift in attention from products to customer services, managers are also seeking granular "costs to serve" customer-related information. These are not all the costs related to making a product or delivering a standard service line (e.g., a bank checking account), but rather they are the costs from interactions with customers, such as a help desk call. The problem with accounting's traditional gross profit margin reporting (i.e., restricted to only product cost profit margins) is managers cannot see the bottom half of the total picture - all the profit margin layers eroded from distribution, selling, credit, payments and marketing costs.
The unacceptable result of not converting these types of expenses into customer costs is that executives, managers and employee teams receive incomplete profit reporting that is not segmented by customer; and the product profitability data they do receive is flawed and misleading. They deserve fully loaded cost and profit reporting that encompasses all the traceable expenses of their end-to-end value stream costs - from supplier-related purchasing to customer service. How can recent advances in managerial accounting methods and technology deploy the vast potential that companies have from their business intelligence systems?
The Quest for Individual Customer Profit Reporting
Businesses with thousands of customers want to scale up their cost and profit reporting and visibility at the individual customer level, but their costing systems cannot accomplish this. As a result, organizations lack the essential information for making much better decisions about product mix, customer mix, marketing, channel strategies and sales programs.
To better analyze revenue, cost and the resulting profit margin information, businesses need to be able to define segmented reports on the fly. This includes tracking profit for different time periods by individual customers, by individual products, and by specific sales channels, distribution channels, branches, service centers or sales outlets. To enhance the identification and investigation of problems, organizations also need the flexibility of at-a-glance and drill-down views to see costs and profits with fine granularity.
In order to overcome the limitations of traditional costing systems - which are hampered by their monthly aggregations of direct costs, excessively simplified cost allocations and resulting lack of visibility for indirect costs - organizations have been adopting transaction-based costing systems. This type of system is based on cost modeling that traces an organization's expenses - both direct and indirect - into the products, services, channels and customers that cause those expenses to be incurred.
The attraction of effective transaction-based costing system is that it can economically scale to accommodate billions of transactions, access data from diverse multiple source systems, and be deployed for remote Web-enabled analysis. It reports validly calculated profits on a moment's notice rather than two weeks after a month has ended. As a bonus, with projected sales volume and mix, it enables reliable what-if scenarios for test-and-learn as well as pro forma profit-and-loss forecasts.
Measuring Customer Lifetime Value
Some organizations have evolved beyond using transaction-based costing solely for obtaining more accurate and relevant historical cost and profit margin information. For these more capable companies, the emphasis has shifted from just measuring costs to measuring long-term potential customer profitability, referred to as customer value management. These organizations use an understanding of their pricing and cost drivers - the measures of work activity that are causal factors in the incurrence of cost - to improve their future operations and profit performance. They leverage their improved understanding of their customers' sensitivity to varying price levels and of their own cost structure, which is made more highly visible with transaction-based costing. With this higher understanding of customer lifetime value (CLV), they proactively manage their resources and induce customer responses (e.g., deals, offers, discounts) to enhance the key elements of value creation from the customer's perspective.1 Organizations involved in business process reengineering, quality improvement, and lean management initiatives also use both the financial and nonfinancial insights from their transaction-based cost measurement systems to increase productivity.