Customer Profitability Analysis: Definition, Benefits, and Challenges
Many companies tend to focus solely on revenue generated by customers. While doing this, they can sometimes overlook the expenses. This isn’t the best approach as revenue is always associated with some costs incurred for marketing etc.
As your company grows, you’d expect your customer base to increase too. Naturally, not all of these customers will interact with your company through the same touchpoints. Therefore, it’s a great idea to keep track of how much you’re spending on acquiring customers and how much revenue they’re bringing you.
With customer profitability analysis, you can find out whether or not your customers are actually profitable considering the amount you’re spending on acquiring them. In this article, you will find out how customer profitability analysis is measured, the benefits of measuring it, and how you can overcome some challenges of measuring the profitability of your customers.
What is customer profitability analysis?
Customer profitability analysis (CPA) is a method that helps determine how profitable a customer is. With this method, you evaluate your customers and determine which of these customers will bring the most benefit to the company.
Let’s explain this with an example.
Let’s say your product is a subscription-based online note-taking app, and you have two types of customers. One of your first types of clients is Bill. Bill uses this app for his personal notes. Thus, he prefers the more affordable pricing option and sometimes makes extra in-app purchases. He heard about your app from a friend and started using it. So there was the minimal expense involved in acquiring him. He also has full knowledge of your app and rarely calls customer support. In short, Bill is a low-maintenance, loyal customer.
Another one of your clients is George. George is a marketing manager and uses your app to stay in touch with his team. For this reason, he prefers one of your expensive pricing plans that promises a lot of features and allows for cross-functional collaboration. On the other hand, George contacts customer support for almost any question. Also, acquiring George also wasn’t an easy feat. He had to be served several ads and went through 3 sales calls before making a purchase. As you can see, George is a loyal customer, as much as Bill. Yet, his loyalty does not come cheap.
In such a case, George may seem like a more profitable client than Bill when you consider the revenues that clients bring in alone. But contrarily, Bill may have a more profitable customer than George. You have to do some calculations to decide this for sure. Let’s take a look at the formulas required for these calculations.
How is customer profitability measured?
The formula for CPA is as follows:
CPA = (Total revenue earned by the customer during the period you set) – (Total expenses incurred to serve the customer in the same period)
Based on this formula, let’s review Bill and George’s annual profitability.
|Annual revenue from subscription||$100||$150|
|Revenue from in-app purchases||$30||$10|
|Customer support costs||$5||$40|
As shown in the table above, Bill generates much more revenue than George. Without a customer profitability analysis, you might think you should focus on customers like George. With CPA, you realize that Bill is a more profitable client than George. So, focusing on retaining customers like Bill will be a more profitable strategy for your business.
Now, while CPA has a formula, you need to pay attention to other elements for an accurate analysis. Here are four steps to a successful customer profitability analysis:
#1 Identify all touchpoints
Your first step in customer profitability analysis should be identifying each touchpoint your customers interact with. Think about your funnel and customer journey. Which marketing channels do your users leverage? How often do they interact with salespeople? What is the cost of your customer success care?
After answering all these questions, it’s time for the next step.
#2 Segment your customers
Once you have identified all these touchpoints, you need to segment your customers. Relying only on demographic information when segmenting your customers will not get you to the full conclusion. That’s why you should also consider behavioral segmentation. This way, you will be one step closer to determining your most profitable customers.
#3 Attribute revenue and costs to each segment
After identifying each customer segment, it’s time to determine the profitability of all these segments. First, calculate the segment’s total revenue. When making this calculation, remember to factor in discounts, upgrades, and cross-sells.
Next, determine the expenses for each segment. Now, the amount may differ based on how each segment interacts with touchpoints. Subtract the cost of each segment from its revenue to calculate the profitability of each market segment. Remember though, you should keep your business expense categories in order for internal control and tax purposes.
#4 Analyze the profitability
Once you’ve completed the steps above, it’s time to analyze and classify the segments’ profitability. Determine which segments yield low, medium and high profits. Based on your segmental data, you can also analyze the factors that cause each market to meet its profitability level and consider the following questions:
- Do your current business strategies serve to optimize this profit?
- In which segments is your strategy more effective?
- What can you improve?
Benefits of customer profitability analysis
The benefits of customer profitability analysis span across multiple departments, from sales to marketing and even product development.
Let’s take a look at some of its benefits.
One of the things you aim for with customer profitability analysis is to attract and retain the most profitable customers. It helps you identify the expenses you incur to acquire your most and least profitable customers. In doing so, you can focus on strategies to reduce costs of more expensive customers.
On the flip side, CPA allows you to identify segments that are not worth your time and resources. In this way, you can stop serving these segments. You can optimize your costs by investing the resources you will spend here in more profitable markets.
Increase operational efficiency
Sometimes customers are not the reason one customer segment generates less profit than another. There may be some elements that cause excessive expenses in intra-company operations.
For example, imagine that a segment constantly encounters the same problem with the product. These customers will consume too many resources to solve this problem every time. In such a case, the reason for not achieving your targeted profitability is the product, not the customers. With a CPA, you can focus on recognizing the problem in the product and solve it to minimize avoidable costs. This way, you can not only lower the operating cost but also make your product better for future customers.
What are the challenges of performing customer profitability analysis?
Although customer profitability analysis has significant advantages for your company, it brings with it some challenges as well. Let’s dive into some of these challenges and see how you can mitigate them.
Leveraging accurate figures for customer costs
When performing customer cost analysis, you must ensure that your data on customers’ revenues and costs are accurate and reliable. The main reason for unreliable information is insufficient data sources. Therefore, it will be complicated to perform a precise CPA if you do not have all the necessary data about your customers or if you suffer from data silos.
One way to solve this problem is by automating data extraction instead of relying on manual data. Tools like HockeyStack show you the entire user journey complete with touchpoints, number of meetings, and other key metrics that you might need to analyze your customers’ profitability.
Analyzing each product separately
Another challenge, which concerns only companies with multiple products, is analyzing the profitability of each product separately. To get the right results from your analysis, you must ensure that you’re considering all expenses and revenue for one product at a time to minimize inconsistencies.
Choosing the right time frame
Choosing the right duration for your analysis is critical. The time frame you choose should be long enough to evaluate the results correctly. In this way, it helps you accurately determine customers’ lifetime values. If you choose a short time frame, you may miss some touchpoints your customer goes through in the sales funnel and miscalculate revenue or cost.
Why measuring customer profitability is important
Measuring and analyzing customer profitability is vital to business success. This is because CPA allows you to identify which customers are making you money and which are making you expend your resources without much return. After analyzing the customer profitability of a segment that you think brings you the most profit, you can realize how expensive it actually is.
All these findings about your customer segments help you run personalized marketing campaigns. You can streamline the sales process by understanding each segment’s needs and costly pain points. In addition, you can create the right marketing strategies for the right audiences and effectively reduce your customer acquisition cost.
Make the right customer decisions with HockeyStack
Now, you know why customer profitability analysis is important, the benefits it offers, and its challenges. But what is the way to overcome all these challenges and perform CPA correctly?
Leveraging an analytics and attribution tool like Hockeystack.
HockeyStack has many features that will facilitate each stage of the CPA and the process afterwards. For instance, I mentioned how important it is to identify customer touchpoints for CPA. HockeyStack automatically collects all actions on the website and on the product. Thus, it helps you visualize your entire sales funnel and marketing journey. This way, you can identify the touchpoints at each step of the funnel, at which points your customers tend to convert, and how many of them churn.
By automating the entire data extraction process, HockeyStack helps you to collect all the data required for CPA. With HockeyStack, you can monitor all your data in real-time in a single platform. You can also manage all the metrics you need in one place with customizable detailed dashboards. That way, you won’t miss any revenue or cost and perform your analysis properly.
The best part about HockeyStack is that it is not only an analytics tool but also a powerful attribution tool. It lets you determine the revenue generated by each segment, which features affect MRR, and much more. Therefore, it also helps you streamline attribution and get the complete picture of your marketing, sales, and customer analysis.
Customer profitability analysis brings a new perspective to your company’s business processes. It helps you generate meaningful insights to identify strategies that increase your income. It also allows you to detect and fix parts where you lose money.
Do you want to analyze the profitability of all your customers and get a holistic view of their touchpoints and behaviors? Check out HockeyStack’s live demo and experience how effortless you can make it!
The main objective of customer profitability analysis is to enable companies to determine how profitable their customers are by subtracting the acquisition cost from the revenue generated by each customer. In this way, companies can determine the cost of acquiring and retaining them and create strategies accordingly.
We can perform customer profitability analysis in 4 stages:
-Identify customer touchpoints
-Segment your customers
-Associate your income and expenses with these segments
-Analyze profitability based on the data you’ve collected