Profitability Analysis
1. Product Profitability Analysis
Original Activity-based Costing (ABC) systems focus on manufacturing costs and their assignment to products. With more accurate product costs generated by an effective ABC system, managers can conduct in-depth analyses of profitability of their products. They can correctly assess the profitability of individual products or product lines to identify profitable products and unprofitable products. .
For companies producing numerous products or models, profitability analysis will become critical because the overall profitability of the company can disguise the poor performance of individual products. It is important to see that all products are profitable in the long run.
ABC database with the information about activities, costs, and cost drivers can provide numerous insights into ways that managers could transform unprofitable products into profitable ones. Pricing strategy can be re-evaluated for each product. It may be possible to identify activities that can be eliminated or performed more efficiently. The decision to drop some of the unprofitable products may be made to improve overall profitability of the company.
2. Customer Profitability Analysis
Studies have shown that only 20 percent of a company's customers contribute to profits and the remaining 80 percent generate losses. Moreover, with increasing importance of customer satisfaction and market-oriented strategy, the costs of marketing and distribution have been increasing rapidly in recent years. These costs are not directly related to the products, but rather associated with individual customers or market segments.
Customer profitability analysis is an approach to cost management that identifies the costs and benefits of serving specific customers or customer types to improve an organization's overall profitability. Just as ABC can reveal product profitability, customer profitability analysis based on the ABC information can identify profitable and unprofitable customers. This piece of information allows organizations to take appropriate actions to increase their profitability.
Like the case of the products, the overall profitability of a company can disguise the poor performance of individual customers. Allocation of customer-related costs to individual customers based on appropriate cost drivers will allow managers to assess the profitability of individual customers or customer groups more correctly.
An analysis of customer differences on both revenues and costs can provide important insight into why differences in customer profitability exist. ABC can also help the company analyze customer-related activities so that customer profiles can be developed.
A customer profile categorizes individual customers according to their major activities that drive revenues and costs. For example, a customer profile for a bank can be based on account balances, transaction volume, types of services used, service fees paid, and number of visits to the bank.
Alternative Courses of Action
Once profitable and unprofitable customers are identified, specific customer-related actions can be taken to improve the company's overall profitability.
• Determine the activities, costs, and profit associated with serving specific customers.
• Investigate why some customers are less profitable than others.
• Take appropriate actions.
o Do nothing.
o Drop unprofitable customers.
o Increase efficiency serving unprofitable customers.
o Help unprofitable customers reduce certain activities.