Uncovering unprofitable customers
The company is the UK's market leader in Premium Product Logistics with over 20 years experience in handling their clients' businesses and brands.
The £17m business had aspirations to grow in a competitive market and become renowned for its service levels and dedication to customer service. To this end it had moved into a brand new purpose built Distribution Centre from which it serviced 19 key customers.
The products always remained the property of their customers. The business processed orders and deliveries to their customers’ customers. The concern was that though they were busy and the warehouse was full, the overall level of profitability was a loss. Management suspected that they didn’t have a clear picture of what the true costs were for each of the 19 customers so were unable to determine the actual profitability nor the causes of the level of profitability.
There were also 19 different types of contract which suggested that the contracts hadn’t reflected how costs were actually incurred so that in some cases revenues must be failing to cover the costs.
If the company was to grow profitably it had to address any current loss making situations and have the right mechanisms in place to ensure that each and every new contract had a very transparent basis for calculating charges to customers and that customers knew how any changes they made to the relationship would impact on the charges.
The cost and profitability model
For each customer, the contribution to profits was calculated by subtracting from its revenue all costs that supported it or that were driven by it. Costs were processed through the model in a number of ‘layers’ that represented the business.
The ‘Resources’ layer allowed better organisation of the ledger data prior to assigning cost to the activities which were in two groups: Front Line (handling and distributing the products and servicing the customers) and Support (such as IT, HR and the like). Sustaining costs such as Annual Audit Fees were part of the costs of being in business and not assigned to customers.
The customer profitability analysis astounded management.
Overall the business was making a loss so it was obvious that some customers were dragging them down. The analysis showed that only one customer was profitable and luckily it was the largest customer by total revenue.
After that, nearly all the high revenue customers were making the biggest losses. In fact the largest loss was coming from the second largest customer!
By grouping the myriad of activity costs and showing how the total for a customer compared to revenue provided the Account Managers with a quick insight into where the major problems were with the costs for that customer.
In the example below, the contract had seriously underestimated the true costs of providing a promotional packaging service.
The analyses in the model showed management where specific actions would lead to healthy gains in profitability in the short to medium term.
Further refinement of the model then delivered many pointers to subtle changes in the business that helped it continue to build a growing and robust bottom line.
The most striking event that occurred was when the customer making them the biggest loss informed them that it was time to renegotiate the charges they received; meaning they were looking for a reduction. Instead the customer was given notice that its business was no longer needed! The model gave management a new resolve to address serious profitability issues.
Why did the project make such a difference to business performance?
In the words of the Managing Director –
“The analysis and modelling approach made all the difference. It uncovered where profits were being made or lost. It showed the underlying reasons for losing money and what we needed to do to turn unprofitable business around. And it gave management the confidence to drop whole segments of unprofitable business when there was no hope of turning it to profit. And the nice twist was when our biggest loss maker went to a competitor who lauded it all over the press how successful it was at wrenching the business away from us. It made our day!”