What Is Customer Profitability Analysis? Formula & Benefits
Customer profitability analysis is a crucial business strategy for supporting your company’s financial health.
Businesses have limited resources. Analyzing customer profitability is one of the best ways to identify high and low-value types of customers and pinpoint which projects are skyrocketing your business expenses.
Learn more about the benefits of customer profitability analysis and the best way to calculate and automate your insights with project budgeting software.
What Is Customer Profitability Analysis?
Customer profitability analysis (CPA) compares the profitability of individual customers or clients within a business. This is done by evaluating the average revenue a customer generates vs the amount a company spends to provide a service or product.
Calculating CPA helps businesses identify their most profitable customer segments and make informed financial and operational health decisions.
How to Calculate Customer Profitability? Customer Profitability Formulas
The customer profitability formula differs depending on your industry and business context:
- A professional services agency, such as a consultancy or marketing agency, would consider revenue from each client vs the direct cost of services, or the number of billable hours spent plus overhead costs.
- A Software as a Service or SaaS company would measure profitability through key metrics such as Customer Lifetime Value (CLTV) vs the Customer Acquisition Cost (CAC). This ratio helps determine how much profit the company can expect from each customer compared to what it spends to acquire them.
- A manufacturing business would consider revenue generated per customer vs the operational costs (materials, labor, machine maintenance). Additional factors include the cost of customization, inventory storage, as well as supply chain management.
You can also use dedicated financial management software to handle your calculations and reporting. Learn more about Budgeting with Productive.
Automate Your Customer Profitability Analysis
Use Productive’s built-in profitability and overhead tracking algorithm to get profit margin insights in real time.
How to Use Customer Profitability Analysis Insights
For an agency managing multiple projects at once, tracking customer revenue is the best way to achieve cost efficiency.
It helps identify high-value customers vs unprofitable customers so the agency can make strategic decisions on resource management and other key business concerns (find out more on capacity planning).
Prioritizing employees, time, and other resources for more profitable projects helps maximize return on investment and ensures that the agency is operating efficiently. For example, if an employee is needed for both projects, you could prioritize scheduling them to the more profitable one first.
Or, if you find out that you’re losing revenue outright, you can decide to drop certain projects and focus on better opportunities:
We ended up terminating contracts with two of our oldest clients after only a few months of using Productive. We thought that we were at least at zero with them, or that we had some small earnings, but it turned out that we were losing money because the money they paid us did not cover salaries, fixed overhead per hour, and variable overhead per hour.
Learn more about scheduling resources for multi-project management.
The Benefits of Understanding Customer Profitability
- Identifying profitable customers: Customer profitability analysis helps identify the most profitable customers. These are the ones you should focus on to maximize your profit margins.
- Informing marketing strategy: By understanding which customer segments are the most profitable, agencies can develop targeted marketing campaigns to optimize marketing costs and get higher ROI.
- Strategic decision-making: With in-depth financial knowledge, businesses are better equipped to make strategic decisions. Resource allocation can be customized to promote long-term customer relationships and customer loyalty within the high-profit customer base.
- Understanding sources of costs: By identifying the cost drivers, businesses get a clear picture of where their money is going. This promotes cost-saving strategies and better investment decisions.
- Enhancing overall financial health: Ultimately, understanding customer profitability improves the financial health of a business. It supports daily agency operations and sustainable business growth.
Main Steps for Customer Profitability Analysis
The main steps for a customer profitability analysis include gathering data and identifying costs, calculating profitability, segmenting your customer base, and developing and reviewing your business strategies.
Here’s a customer profitability analysis example:
1. Gather Data
First, the business must gather relevant customer data and identify the main cost drivers.
Cost drivers are factors that influence operational costs and can vary significantly from one industry to another. For example, a manufacturing business would track cost factors such as raw materials, energy consumption, and supply chain logistics.
For a professional services agency, the most significant cost drivers are labor costs or direct costs. This includes salaries, benefits, and investments in professional development.
Otherwise, it can also include indirect costs. This includes costs for tech, such as licenses, subscriptions, and office space.
2. Allocate Costs
Once you’ve identified the specific costs your business needs to take into account, it’s time to allocate them per customer or client.
In the example of a design agency, each client is associated with a specific cost of offering services. This includes employee cost rates or salaries, as well as overhead.
For example, for an employee with a salary of $5,000 and a 40-hour workweek, the estimated hourly cost of their work amounts to $25.
Now, let’s imagine that the employee is scheduled for a project billed at $100 an hour. The profit would look something like this:
WITHOUT OVERHEAD, your project profit would amount to billable rate against cost rate
When it comes to overhead costs, it can be labeled in different ways – for example, Productive distinguishes the facility cost (office space, utility, and equipment) and internal cost (time spent on internal work).
Productive calculates this overhead per hour worked to help you get insights into actual profit per customer.
For example, an agency with a $5,000 monthly facility cost would have $10,24 of overhead cost per hour.
ONCE YOU ACCOUNT FOR OVERHEAD COSTS PER HOUR, YOU GET YOUR ACTUAL PROFIT PER HOUR
Once you’ve crunched the numbers, it’s time to get into your profit margins.
3. Calculate Profit Margins
Profit margins are calculated by subtracting costs from revenue generated by clients. CPA can also be calculated on an annual basis by tracking annual revenue against the average cost incurred by customers.
With Productive, all of this data is analyzed in real time, without gathering numbers by hand and using countless spreadsheets:
From a managerial point of view, the main benefit of Productive is seeing your profitability in real time. It’s there. We don’t have to calculate it or ask for financial reports from our accountant.
Read how Productive helped a digital agency get the most out of its resources.
You can also use Productive to forecast your profit margins and revenue before a project is completed — this can help you make better scheduling and project management decisions for the project and agency health.
Automate Your Customer Profitability Analysis
Use Productive’s built-in profitability and overhead tracking algorithm to get profit margin insights in real time.
4. Segment Customers
Next is customer segmentation, which allows businesses to customize their services and strategies to meet the needs and characteristics of each customer base.
Customers can be segmented according to:
- Revenue generated
- Service demand
- Industry
- Customer behavior (engagement, loyalty, customer age, etc.)
For example, high-revenue clients might be segmented as key accounts requiring dedicated resources and customized service offerings. Conversely, smaller or less profitable clients might be grouped for more standardized, cost-effective service solutions.
Strategic segmentation is beneficial to both parties — it helps businesses get an in-depth understanding of their client and their needs. This usually leads to improved service and customer satisfaction.
On the other hand, agencies get the benefit of a strategic approach to their resourcing and decision-making, resulting in improved agency operations.
5. Develop an Action Plan
The next step is to develop on actionable plan based on gathered insights. This includes tailoring your services and your capacity plan based on accurate data.
If a client is incurring more costs than profit, consider the reasons. Are you allocating high-cost and high-value employees where mid or junior-level workers could do the same job? Are employees spending more hours than estimated on tasks due to communication gaps and constant back and forth?
Or, if you’re working on retainers that are no longer profitable due to internal or external factors, you can consider raising prices. You can do this by:
- Setting the expectation for potential price increases at the start of the collaboration
- Maintaining regular communication with the client to increase transparency and loyalty
- Explaining the difference between your rates for new and existing clients and why you need to bridge the gap — for example, to maintain the same level of quality.
If all else fails, you can consider ending your relationship with the client to focus on projects that support your revenue growth and future business goals.
6. Continuous Reassessment
Regular updates to the analysis ensure that your business is aligned with changing client needs, market trends, and internal capabilities.
Consider relevant and recent industry data. For example, according to the Wow Company, companies should aim for a gross profit percentage above 50%. In 2022, the average profit percentage was 40%.
This ongoing evaluation supports a proactive approach, allowing the agency to adapt and refine strategies effectively over time.
Top Challenges in Customer Profitability Analysis
The top challenges of customer profitability analyses usually include getting timely data, making the right decisions for your business health, and accurate financial forecasting.
Getting Real-Time Data
More than half of agencies don’t have integrated platforms that enable real-time or detailed analysis of business health. In fact, only 33% of agencies track their project gross margin (SoDa & Productive).
Most agencies use disparate PSA or project management systems, making data consolidation difficult. Comparing project performance is significantly harder when your expenses are dispersed and calculated differently across systems.
To address this challenge, consider implementing an all-in-one tool that can gather insights into your expenses and deliver profitability reports in real-time.
Related: Business Budgeting Software for Small Business
Saying No to Clients
According to PRWeek, nearly one in five agencies are overservicing every single client, and only 8% of agencies report that they never overservice.
The main solution? Saying no to clients (when necessary).
This can be difficult for multiple reasons: fear of losing business or getting negative word of mouth, unrealistic client expectations, or internal culture. Some clients can also be more demanding than others.
Even if you establish the scope of work during project planning, requests for changes often happen during the execution.
To handle these issues on the go, maintain clear and transparent communication. If a client understands your capabilities, you’ll be more likely to reach a mutually beneficial compromise.
We also love the ability to invite our clients into the projects. It takes the middle man out of the equation, no need to go back and forth via e-mail, we can get all of the feedback within Productive. This also lets the client see how much work is actually going into the project and you can see that they have a greater appreciation for what we do.
Learn more about how an award-winning creative agency streamlines operations with Productive.
Accurate Budget Forecasting
In addition to data integration and client management challenges, another significant hurdle is maintaining accurate budget forecasting. Many businesses struggle to predict customer costs accurately, leading to financial discrepancies.
To mitigate this, agencies should utilize advanced forecasting tools that leverage historical data and predictive analytics. This approach can enhance budget accuracy, allowing for better financial planning and reduced risk of overspending.
Productive forecasts key business metrics based on your resource scheduling
Strategies to Improve Customer Profitability
- Enhance your data tracking: Use real-time analytics to identify high-value customer segments and develop business strategies to target these groups.
- Optimize pricing strategies: Consider which pricing model is best suited for specific clients and projects — from fixed pricing and retainers to productized services.
- Streamline business operations: Analyze your processes and streamline costs by addressing inefficiencies in the project management or production process.
- Focus on talent retention: Losing talent can impact your team’s stability and incur additional costs for replacing and building up the skills of the new staff member. Focus on retention strategies to mitigate this challenge.
- Manage customer success: Implement CRM systems and practices to ensure consistent, positive customer outcomes. This boosts satisfaction, increases loyalty, and enhances long-term profitability.
Future Trends in Customer Profitability Analysis
The future of customer profitability analysis is utilizing the latest software for reliable insights. AI and machine learning, financial forecasting, and real-time data processing are all essential tools to maintain a competitive advantage.
If you’re looking for the top software for financial management, consider Productive, the all-in-one agency management solution.
Get complete control over your project financials with Productive
Productive offers features that can help you streamline various aspects of agency operations, from resource planning and budgeting to in-depth reporting.
Key features for optimizing profitability include:
- Centralizing team and client communication
- In-depth insights on resource availability and allocation
- Visualizing and forecasting utilization, profitability, and project progress
- Streamlined time tracking and client invoicing
- And much more
Book a demo today to find out how Productive helps you invest into your agency’s future.
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