Customer Profitability Analysis: Benefits, Formula, and Step-By-Step Guide
Updated April 21, 2023.
Customer profitability is the difference between the gross profit margin earned on a customer and the cost incurred to acquire them. Most businesses determine customer profitability with the help of a cost and profitability analysis.
This analysis helps prioritize clients, services, and marketing campaigns in order to increase profitability. It considers the costs of servicing each customer and the profits made by maintaining that client. The analysis measures the profitability of new customers versus existing and retained customers.
Step-By-Step Guide to Customer Profitability Analysis
1. Determine Cost of Servicing Customers
A good place to start a customer profitability analysis is by determining the expenses incurred by obtaining and retaining your customers. These costs include:
- Customer support
- Staff wages
- Transit and shipping
Once you’ve determined what each customer is costing you, it’s time to designate them into separate groups.
2. Segment Your Customers
Segmenting customers based on their profitability to a business is important to a customer profitability analysis because it allows for the identification of high-profit customers. This information can be used to ascertain what customer segments are worth targeting, how much they are worth, and what they are most likely to buy from you.
There is no definitive way to do this, but you could determine the groups by profit ranges that you define as "worth it" and "not worth it."
3. Track Your Data
Now onto the most important part of any analysis, data tracking. Data tracking is the only way to accurately and consistently quantify outcomes, such as those represented by metrics like ROI (return on investment) and TCO (total cost of ownership).
Customer profitability analyses also help to forecast what will happen in the future. Data can be used to see how customers are behaving now and predict what they will do in the future, which can help a business determine which products they need to focus on and where they need to provide better service.
» Discover how you can increase your profit margin in e-commerce
Advantages of Customer Profitability Analysis
A customer profitability analysis offers businesses substantial advantages. This type of analysis helps:
- Optimize customer acquisition strategies
- Find new customers with the maximum potential profit
- Identify customers that are not profitable
- Reduce customer churn and increase customer retention
- Create segmented customer lists
How to Calculate Customer Profitability
The product profitability calculation looks like this:
Total profit per customer = (total generated revenue) - (total incurred costs)
In a real-life profitability analysis example, the formula looks like this:
Customer A places an order totaling $450, but the cost incurred to the business to entice them to make these purchases was $300. Therefore, the total profit generated from customer A stands at $150.
Customer B places an order totaling $300, but the cost of enticing the purchases they made was only $50. That makes the total profit for customer B $250
Even though the revenue attained from customer A was $450, which was $150 more than customer B, they were not the more profitable customer. The cheaper cost of acquiring customer B made them $100 more profitable than customer A, even though the total order amount was less.
We suggest that you read more about the mistakes to avoid when calculating profitability to ensure that your figure is accurate.
How to Benefit From a Customer Profit Analysis
The data generated by a customer profitability analysis can be used to optimize marketing and sales activities by determining which customers are profitable and which should be prioritized. Once customer profitability has been assessed, it's possible to determine if one customer segment is more profitable than another, or if a certain group of customers has a higher profit margin than expected.
The insights gained from this type of analysis are also perfect for creating marketing strategies that will boost a business’s overall profitability. This may include the following methods:
- Customer segmentation strategies Implementing a customer segmentation strategy to identify consumer groups with maximum profit potential and create a targeted marketing campaign for these segments.
- Building brand loyalty Increasing the number of customers who buy goods at full price by building brand loyalty among shoppers will entice them to become regular shoppers and spenders, increasing the total long-term revenue without spending more on acquiring new customers.
- Using discounts sparingly Discounts can be a great way to acquire new customers or hold on to existing ones but can undermine profits if used too frequently.
If you’re serious about determining the profitability of your customers, use the BeProfit app to easily conduct various profit analyses.