What is the True Cost of a Customer?

You May Be Surprised That Some Actually Cost You Money

Most suppliers precisely know their gross margins on a per-customer basis. Assume you’re a business with 40% gross profit margin. Of those 40 points, 25 are usually consumed by overhead, leaving you with a 15% net margin.  Some suppliers are higher, some lower.

Very few know their net margin on a per customer basis.  If you think about what goes into “overhead,” they are things like delivery expense, sales and marketing, cost of bank borrowing, legal expense, etc.  Are these expenses consumed by your customers in direct proportion to their sales volume?  I’ll save you the suspense – they’re not.  As a result, if you took the effort to allocate those expenses by what each customer actually consumes, you’d find your true net profitability for each customer.  What you will realize is that not all customers contribute equally to the bottom line.

To highlight this point and show where perceptions can be wrong, let’s take an example. Ask yourself: Are large customers more profitable than smaller ones?

It’s possible. It also might prove the opposite. Your big customers typically get the best pricing for their large volumes, which means a lower-than-average gross margin to start. Instead of making 25% gross margin, you may be making 19%, before your overhead is paid down.

And the margins for large customers can get even thinner: Big customers often get the attention of your top salesman, they get specialized delivery, and favorable return/restock terms. When a dispute pops up, you are quick to accept responsibility and accommodate without delay. After all, they’re a big customer, right?

Now look at the big customer from the perspective of A/R. Perhaps these customers routinely hit you with chargebacks, some not even warranted.

Add all that up, and you may not be making 5% net margins, but shocked to find you are not making any money at all! Trust me, that’s more common than you might expect.

To calculate per customer profitability, attempt to allocate the share of “overhead” expenses each customer is actually driving.  Look especially in the following areas:  delivery expense, disputes, how quickly or slowly they pay their bills, who pays with credit cards, % late charges collected, restocking and dispute fees, and sales expense.   If there are other overhead categories where it’s clear some customers are driving a disproportionate amount of the expense, then allocate those too.  Make sure after you’ve attributed the expenses that the sum of the allocations is neither higher nor lower than your actual total.

Next, subtract these expenses from the gross-margin per customer you already have and that’s it.  If you are like most suppliers, you’re going to find some powerful insights . . . some customers are making you a lot of net margin % that you didn’t realize (usually smaller customers that don’t get special attention) and some customers may be making you less net margin than you thought.  Some may even be negative in their profitability!

What to do with those customers?  Fortunately, you have lots of ways to improve low or negative net margin customers.  Pricing is a great place to start.  If that isn’t easily movable, think about collecting late fees from them the next time they are late.  Consider how you can reduce expenses that that customer is explicitly driving.

If low or negative net margins can be attributed to issues with A/R, consider bringing in a credit management provider like BlueTarp. BlueTarp provides efficiency gains from automation and customer self-serve tools, which reduce your costs while providing a better customer experience.   Whatever you choose, take heart in knowing that you now have the right insights on true profitability per customer.  Knowing that is more than half the battle.


Interested in learning more?
Check out four ways A/R automation can cut costs while improving customer experience