Profitability is the fundamental metric by which any business is judged. If a business is failing to turn a profit, it will not necessarily fail; however, it will be on thin ice financially, and under extremely close scrutiny from investors and competitors alike.
Profitability is heading for a nosedive in every industry, as a recession looms in the UK. The impending economic shrinkage is inspiring many businesses to re-evaluate their relationship with profit – with one calculation proving useful in finding a smart path to growth.
What is Customer Profitability Analysis?
Customer Profitability Analysis, or CPA, is a specific form of accounting process designed to understand the profit potential of specific types of customers. Traditionally, ‘profitability’ as a concept is pinned to the product; we figure out the turnover of our businesses by offsetting the operating and manufacture costs with the retail performance of the products we produce. Overheads and wholesale costs per product are subtracted from the retail price to give a profit margin, and monthly sales figure predictions do the rest.
CPA shifts the focus away from the product itself, and towards the customer receiving the product. It aims to refocus the business’ approach to understanding costs, and demonstrate the ways in which different demographics can impact potential returns.
For example, a business that sells IT solutions to both retail customers and commercial enterprises will spend different proportions of money on consultancy and install, depending on the customer. The individual customer may need a five-minute installation performing, where an office might need multiple staff members and multiple visits over a long period of time – costing more to implement in the process.
Why Should You Calculate CPA?
CPA is a potentially vital figure to track in order to facilitate shrewd and smooth business growth. As part of a wider consulting strategy, CPA can be useful in targeting wasteful expenditure; through examining the specific costs each type of customer incurs per product sold, you can better pivot to maximising income without stressing other departments.
In this way, CPA might help you transition your business to an overall more profitable model, whether discontinuing certain forms of service in favour of others or simply shedding costly elements of your product delivery process.
How Can Your Calculate CPA?
The method for calculating CPA will naturally differ from business to business. Typically, the breakdown of costs per customer will bear the same hallmarks of any revenue calculation. You will need to account for research, development, marketing, sales man-hours and logistics.
While the makeup of your raw CPA figures will be unique, the formula itself is the same for every business – and essentially the same as standard product profit figures. All you are doing is dividing your customers by demographic, and dividing the relevant proportion of profits they generated – and costs associated to them – by their volume. One is subtracted from the other, and, for the average customer, the resulting figure is multiplied by average length of business-customer relationship.
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