I came across an interesting article titled "Solving the mystery of customer lifetime value," by Brian Plowman of Develin Partners (based in the UK). He makes a convincing argument that while most companies focus on revenue, customer count and gross margin to assess profitability, that a more rigorous ABC (Activity Based Ccosting) approach can paint a very different and sobering picture indeed. Because I had some trouble understanding the graph presented in the article [see below], I wrote to Brian asking for clarification. He wrote back with a much appreciated explanation of the "hook curve" as he calls it — including additional exhibits and case studies of how Develin's ABC costing approach can reveal the sad truth about the lack of profitability in what might otherwise appear to be a thriving business. Brian argues convincingly that the profitability of [virtually] all companies is represented in some form of the hook curve. Moreover, he reveals that a surprising - if not frightening - number of customers are often found to be unprofitable when the true costs of delivering the company's products and/or services are taken fully into account. Here first is the original graph from his article (viz. the graph I had trouble understanding).. 
Trying to determine precisely what each axis represented left me dazed and confused. But a different exhibit, following our email exchange, made things much clearer…
In this example, roughly 40% of customers prove to be unprofitable following an ABC analysis. This group erodes the overall profitability of the business due to the high cost of servicing their accounts. The next step is to determine why these customers are unprofitable and to look for ways to reverse that trend — ultimately either by lowering costs or raising prices. For example, some customers may be receiving service(s) at a higher cost to the company than the norm. Special orders and rush deliveries, for instance, would increase the cost of fulfillment and consequently could make a given sale unprofitable. A customer who atypically and routinely drains a companies resources beyond the norm might prove quite unprofitable in the final analysis.
Brian also provided some examples from his consulting practice that drive the point home even more ..
Finally, here's another representation of the hook curve which I think helps to bring the matter even more clearly into focus.
I think there's considerable merit and food-for-thought to be found in this ABC costing approach to profitability analysis.
// lm
April 15th, 2009 at 12:29 am
Great Article Lloyd. The insights on analytical marketing were quite educational.
April 15th, 2009 at 12:30 am
Great Article Lloyd. The insights on analytical marketing were quite educational.
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