Summary by Jackie Margarella
Master of Accountancy Program
University of South Florida, Summer 2001
Customer Profitability Main Page | Performance
Measurements Main Page
Customer account profitability (CAP) represents an important future direction of management accounting. CAP provides management with a way to analyze customer sales to determine if the Company (as a whole) is profiting from doing business with a particular customer. Most management accounting systems today focus on product cost and profitability by department or geographic location. Although CAP is a relatively new idea, its theory is simple and easy to understand. The key idea in CAP is that each dollar of revenue does not contribute equally to net income (page 5).
Key features of customer account profitability
First, CAP captures and assigns costs to individual customers, not products, services or departments. This allows management to determine if a particular customer is profitable or if the Company should charge a higher price.
Second, CAP analysis can be used at either a very aggregate or a very disaggregated level. This allows management the flexibility to either analyze a particular customer or a large group of customers at a time.
Third, CAP focuses on multiple products sold to a single customer rather than a single product sold to multiple customers. This change from a product cost focus to a customer cost focus gives management a clearer picture of downstream costs that are customer specific (i.e. customer service, marketing, and distribution). This allows management to strategically select which customers to target.
Differences in customer profitability arise from either differences in revenues or differences in costs. Therefore CAP requires a detailed analysis of revenues and costs by customer. Differences in revenues arise mainly because of differences in price per unit charged to customers. Several CAP studies have found little economic rationale to discounts provided to customers. Discounts are often given to customers to meet short-term revenue goals, regardless of profitability. Differences in customer costs arise from the way customers use the company’s resources. Most of this cost difference lies in the usage of downstream functions such as customer service, marketing, and distribution. For example, some customers require a lot of customer service time, while others require none at all. CAP properly allocates these costs to customers who utilize downstream services and offers lower prices to those customers who do not.
Challenges to CAP Analysis
There are some challenges that management must overcome to analyze customer account profitability.
First, management must develop reliable customer revenue and customer cost figures. Most often the reason for unreliable information is due to inadequate information systems. CAP requires a system to accumulate information across all business functions and geographic areas. Most systems used today are unable to perform this necessary function.
Second, management must recognize and estimate future downstream costs of customers. Two areas that are especially challenging are environmental and litigation costs. Simply assuming that future liability costs will be zero can lead to a substantial overstatement of customer profits.
Third, management must incorporate a multi-period horizon into the analysis. Customers that are unprofitable during one period may turn out to be profitable in the long run. If management only focuses their attention on current period reports, they may decide to drop the customer who in the long run would be profitable.
The final challenge that management must overcome to analyze customer account profitability is to recognize different drivers of customer costs. Original customer profitability reports assume that all costs are variable in the long run and none of the costs are joint. However, relaxing these assumptions may lead management to more accurate reports.
Customer profitability analysis emphasizes the importance of attracting and retaining profitable customers. This is still a relatively new area of management accounting, and much research still needs to be done. However, the underlying principle is simple, each dollar of revenue does not contribute equally to net income. Therefore, management should analyze their customer base and determine which customers to serve.
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Related summaries:
Guilding, C. and L. McManus. 2002. The incidence, perceived merit and antecedents of customer accounting: An exploratory note. Accounting, Organizations and Society 27(1-2): 45-59. (Summary).
Howell, R. A. and S. R. Soucy. 1990. Customer profitability: As critical as product profitability. Management Accounting (October): 43-47. (Summary).
Manning, K. H. 1995. Distribution channel profitability. Management Accounting (January): 44-48. (Summary).
Martin, J. R. Not dated. Product life cycle management. Management And Accounting Web. (Summary).