As a business owner, your company's appeal isn't going to be completely specific. Your business won't unilaterally appeal to a single group of customers comprised entirely of buyers with identical habits, backgrounds, and budgets. As your business expands, you'll probably come away with a more diverse base of customers.
Different types of customers are bound to interact with your business in different kinds of ways. That means they'll drive different means of revenue and extract unique costs. Put two and two together — they're going to offer you different kinds of profit.
The specific amount of profit you stand to gain from each of your customer groups or personas is known as customer profitability. Here, we'll explore the concept a little further and get some perspective on how to conduct a customer profitability analysis.
Customer Profitability is essentially a measure of how profitable a specific customer is. It compares how much revenue a given customer generates with how much that company spends on acquiring or retaining that customer — in time, resources, or other costs.
Let's imagine two customers, Patrick and Patricia and pretend you sell a particularly potent strain of catnip.
Patricia buys your catnip in bulk — so much so that you wonder if she's using it recreationally or something because nobody has that many cats. She's never returned an order and she rarely calls customer support. She's a low maintenance, loyal customer.
Patrick, on the other hand, buys his orders in small quantities. He prefers several tiny, individual boxes of catnip as opposed to larger orders — more than half of which he returns immediately. He's constantly calling customer support about how to calm his cat down after your product, "makes her freak out to the point that [his] girlfriend doesn't want to come over to [his] condo anymore." In all, Patrick is a loyal customer, but his loyalty isn't cheap.
You, the catnip mogul, stand to make more money from one of those customers than the other. If their buying patterns hold true, Patricia is a more valuable customer than Patrick. That example is a very high-level, cat-oriented demonstration of customer profitability.
With that concept in mind, here are some formulas that can give you a high-level overview of how profitable specific customers might be.
Customer Profitability Formulas
Customer profitability analyses are detailed, labor-intensive, and difficult to implement. However, there are some metrics that can give you a rough, baseline picture of customer profitability.
Though they don't capture the intricacies of a full customer profitability analysis, these equations can offer you some perspective in terms of how much you're making off different types of customers.
Customer Lifetime Value (CLV)
The first formula is Customer Lifetime Value (CLV). It gives you a picture of net profit gained from a customer over the time they've done business with your company.
The formula doesn't consider any costs behind the initial cost of acquisition, and it also doesn't give you much insight into why they've stuck with you or what you stand to gain going forward. Regardless, it's still a valuable metric to keep track of when you want a rough projection of where a customer relationship could head.
Average Revenue per User (ARPU)
Another useful metric within the context of projecting customer profitability is Average Revenue per User (ARPU). It can tell you how much revenue you're generating from subscribers of a specific service or customers who fit a specific mold.
Like CLV, it isn't necessarily predictive of your customers' behavior. It also only lets you know which customers are generating the most revenue — not the most profit. Still, it provides a solid starting point for understanding your customer profitability.
Though these formulas can give you a rough overview of your customer profitability, the best way to truly understand the value of your customers is through a customer profitability analysis.
How to Perform a Customer Profitability Analysis
A customer profitability analysis can be nuanced, difficult to implement, and hard to draw definitive conclusions from. Still, it offers insight into your customer base and earning potential that other equations, analyses, and processes can't.
1. Identify your touchpoints.
Start by determining all the different touchpoints your customers have with your business. Make sure you're comprehensive in addressing each one — this includes customer service, social media, paid marketing efforts, and any other way you interact with customers. Once you've conducted this audit, identify exactly how much it costs to maintain each channel.
2. Segment your customer base.
Next, you should segment your customer base. One of the simplest, most effective ways to do so is through buyer personas. As per HubSpot's own definition, a buyer persona is "a semi-fictional representation of your ideal customer based on market research and real data about your existing customers."
If you can separate your customers on that basis, you'll put yourself in a position to analyze and identify profitability based on customer behavior and background.
3. Determine how much each segment costs and spends.
After you've segmented your customer base, you'll need to find the data relevant to establishing customer profitability. You want to see how much your personas spend on and cost your business. Generally speaking, you should be able to find these figures grouped together by category in your income statement.
If you run an eCommerce business and ship packages, look at your package-return figures. You can identify how much each costs you on average. Then, you can identify how the average rate at which a given segment or persona returns packages. Use that figure to assign an average cost that buyer persona will generate in returns.
Repeat that process with every touchpoint between your customers and your business — identify the cost for each interaction or contact. This can include customer support inquiries, marketing efforts, social media campaigns, packaging, and shipping.
Compile the average cost per transaction for each persona. Now, you can calculate customer profitability by comparing that figure with the average revenue each persona generates per transaction.
Customer Profitability Example
In the comparison above, Persona B generates more revenue than Persona A, but Persona A is more profitable. If you were to take the two personas at face value — without having conducted a customer profitability analysis — you would get the impression that Persona B is inherently more valuable to your business.
However, given all the other factors beyond the revenue each persona generates, it might suit your interests to pay more attention to persona A.
Why Does Customer Profitability Matter?
Having an understanding of which customers stand to make you the most money from can inform smart, strategic business decisions across your company.
A thorough customer profitability analysis can be central to an efficient sales strategy. By segmenting your customer base and identifying the most lucrative opportunities within it, you can better understand which prospects are going to help your business most and tailor your sales efforts accordingly.
You obviously want to land customers and clients that are going to help your bottom line. With a customer profitability analysis, you can get a picture of who those prospects are and how to reach them.
A customer profitability analysis puts a new degree of insight into your sales process. It can help you from pursuing prospects that will have underwhelming returns or possibly even lose you money.
The concept of applying customer profitability findings to your customer service practices might seem a bit touchy. But the reality is your company has a fixed amount of service resources and certain segments within your customer base that are more lucrative than others.
That's not to say you should ignore every persona besides the one that's making you the most money. You should still offer exceptional customer service to everyone using your product or service. But, there are some ways you can offer preferential treatment without alienating the rest of your customers.
You can offer more profitable customers shorter wait times, more direct lines to your staff, access to exclusive content, and any other steps you can take to accommodate their interests.
Customer profitability is an interesting, valuable metric to consider when structuring your sales, marketing, and service efforts. That being said, you shouldn't look at the metric as the end-all-be-all of how to approach your customers. You still need to provide exemplary service to anyone you do business with.
So, just because Patricia buys your cat-nip wholesale doesn't mean Patrick's customer service inquiries about how his cat won't stop licking his walls don't matter.
Originally published Mar 3, 2020 8:00:00 AM, updated May 05 2020