SEMINAR IN MANAGEMENT ACCOUNTING (MAF651)

PREPARED BY: NAME MATRIC NO.

1. SITI AMAL NOORAINA BINTI ABDUL MANAF 2017638966

2. NURFATIHAH BINTI ZA’BAH 2017638894
GROUP 4 MEMBERS
3. NUR HAZIQAH BINTI SAMSUL ANUAR 2017638944
4. SITI HAJAR BINTI MOHD AZMAN 2017638838

5. ZARITH SOFIA BINTI NASUHA 2017649058

6. NURASMIRA BINTI MOHD PUZI 2017638992
7. WIDAD HAYATI BINTI ABDUL GHANI 2017639158
GROUP 5 MEMBERS
8. HUMAIRA SYUHADA BINTI ITHNIN 2017638856
9. IZZATI BINTI ARIFFIN 2017638894

10. NURUL AKMA ZULAIKHA BINTI ADZHAR 2017639052

11. NUR AININ SOFIA BINTI NURUDIN 2017639262
12. KHAIRUNNISA SYAFIQAH BINTI KHAIRUL SHAHRIN 2017668564
GROUP 6 MEMBERS
13. HAMIZAH AMININ BT MOHD SAUPI 2017639264
14. NURUL RABAITUL NAHIMA BINTI AWANG 2017639256

CLASS AC2208H

LECTURER’S NAME ASSOC. PROF. DR NORZIATON ISMAIL KHAN

SUBMISSION DATE 13th APRIL 2020

CUSTOMER PROFITABILITY ANALYSIS (CPA)

 TABLE OF CONTENT

No. CONTENT PAGE

1. INTRODUCTION 1
2. DEFINITION OF CPA AND CUSTOMER ANALYSIS 2
3. PURPOSE OF CPA AND STEPS TO IMPLEMENT CPA 3-4
4. ADVANTAGE AND DISADVANTAGE OF CPA 5-6
5. COST INCURRED IN IMPLEMENTING CPA 7
6. CHALLENGES OF CPA 8
7. HOW ABC CAN IMPROVE THE UNDERSTANDING OF CPA 9
8. REAL CASE OF IMPLEMENTATION OF CPA 10
9. THE REASON BEHIND THE INCREASED CONCERN OF CPA 11
10. CONCLUSION 12
11. REFERENCES 13
1. INTRODUCTION
Customer Profitability Analysis (CPA) is a management accounting method that
allows businesses to determine the profitability of each customer or segments of
customers. CPA does this by attributing profits and costs to each customer separately. It
can be applied at an individual level or at the group level. CPA analyses past events of
different customers to calculate the profitability of each customer, which it might be a
disadvantage as the past is not always the determinant of the future. However, there are
always ways to overcome difficulties.
The main purpose of CPA is to provide the understanding of each customer
profitability to organization’s management. Grouping this information into customer
profitability segments will allow companies to take different, targeted actions and
strategies against different profitability segments, having as a target increasing the
company’s total profitability.
This paper will cover on what is CPA, its main purposes and how it could be
implemented effectively, as well as the costs to be incurred in implementing it. Other
than that, it will provide more insight on its benefits and limitations to organizations, and
the challenges a company will face in implementing CPA, how it can be improved.
Finally, we will provide a real example of a company that implements CPA as well as the
reasons why there are increased concern of CPA.

1
 1. DEFINITION

Customer Profitability Analysis (CPA) is a management accounting and a credit underwriting

method, allowing businesses and lenders to determine the profitability of each customer or
segments of customers, by attributing profits and costs to each customer separately. CPA can
be applied at the individual customer level which is more time consuming but providing a better
understanding of business situation or at the level of customer aggregates or groups. For an
example, the grouped by number of transactions, revenues, average transaction size, time
since starting business with the customer, distribution channels, and others.

2. CUSTOMER ANALYSIS

A customer analysis is a part of a company's business plan or marketing plan. It identifies target
customers, the needs of these customers, and then specifies how the product satisfies these
needs. A customer analysis can be broken down into a behavioral profile and a demographic
profile.

A customer profile is a simple tool that can help business better understand current and
potential customers, so they can increase sales and grow their business in the future. Customer
profiles are a collection of information about customers that help determine why people buy or
don't buy a product. Customer profiles can also help develop targeted marketing plans and help
ensure that products meet the needs of their intended audience.

A behavioral analysis of customers (or psychographic profile) seeks to identify and weigh the
relative importance of factors consumers use to choose one product over another. These
factors, sometimes called buying criteria, are key to understanding the reasons that customers
choose to buy your product or services, or the products offered by your competitors. The major
criteria that customers use to distinguish competing products are price, quality, convenience
and prestige.

By identifying customer needs through market research and analysis, companies can develop
benefits that customers can expect from the company's products. And once the buying criteria
have been identified, marketing efforts can influence the customer's perception of the product
along the four major criteria which is price, quality, convenience and prestige that is relative to
the competition's product.

2
 3. PURPOSE OF CUSTOMER PROFITABILITY ANALYSIS (CPA)

In implementing an analysis in a business, it supposedly drives it to achieve company target and

goals. Hence, the purpose of implementing Customer Profitability Analysis is:

 Customer profitability is crucially important for continued business success because it

helps determine whether certain customers are costing you money or making you
money. These findings can help shape and shift your business strategy to keep your
initiatives and goals aligned.
 Customer profitability Analysis also help a business to focus on maximizing the most
profitable customer group, in addressing the root cause of any lagging customer
segments and getting profitability back in track by asking their self either:
o The policies that being used in the company should be implemented to prevent
some cost or not?
o Should the company consider implementing automation or tools to ease the
process of buying and selling?
 Customer profitability helps formulate different pricing techniques for different product
and customer.
 Customer profitability analysis helps in retaining customers as programs and put them in
place to retain the most profitable one, hence its resulting is customer satisfaction and
loyalty.

4. STEP TO IMPLEMENT CUSTOMER PROFITABILITY ANALYSIS (CPA)

Customer Profitability Analysis (CPA) approach generally is based on segmenting the customer
base. It is because to determine the revenues and costs attributable to each segment. This is
often combined with an activity-based costing (ABC) approach. There are six key steps in this
CPA approach that we need to follow.

The first step is customer segmentation. The basis for customer segmentation will be vary
across companies and across industries. Currently, there are two basic approaches to customer
segmentation which are demographic and psychographic segmentation. Demographic
segmentation is based on observable characteristics such as geographic area, customer age
and sex, and income level while psychographic segmentation based on customer needs and
behavior such as customer values, attitudes and interests.

3
Next, for the second step is revenue attributable to each segment. Once segments have been
identified and the annual revenue is calculated per segment. This step can be done depend on
the products or services offered by the company. Adjustments to the price paid by the customer
for a product or service, such as discounts or service fees must be included to determine the
true amount of revenue that generated by each customer and the aggregated amount
calculated for the customer segment.

The third steps to implement CPA approach is by using ABC to determine the cost attributable
to each segment. The annual cost is calculated per segment. This will involve both directly
attributable product or service costs and customer costs. It is including allocation of overheads,
marketing, sales and distribution costs.

The fourth step is analyzing the profitable versus less profitable or unprofitable customer
segments. The profitable customer segments are those whose annual revenues exceed annual
costs. As the profitability of customer segments is vary from year to year, a more accurate
analysis could involve calculating profitability over the lifetime of each customer segment.

For the fifth step is to develop strategies to maximize profits from profitable customers and
reduce or eliminate less profitable or non-profitable customers. For a profitable segment of
customers, this step involves detailed planning on building long-term customer relationships to
increase revenue, and hence profitability such as customer retention and loyalty programmers.
There are two main actions can be used which are elimination and re-engineering to address
the profitable and non-profitable customers group.

Lastly, for the sixth step is about review the impact of the new strategies on the performance of
the customer segments. The implementation of any new strategy, such as changes in pricing or
cost reduction, it should be reviewed after an appropriate period to determine the impact
towards customer profitability.

4
 5. ADVANTAGES OF CUSTOMERS PROFITABILITY ANALYSIS

The advantages of CPA are to assist companies to assess the value of a customer or
customer category and to analyze how marketing and support services should be allocated to
customers. Customer Lifetime Value Many companies see the importance of considering the
long-term value of the customer, as well as the expected contribution to profit over the long-
term, in deciding whether the company should keep the customer. This concept is known as
customer lifetime value (CLV). CLV is a way for companies to assess the value of a customer or
customer category and to analyze how marketing and support services should be allocated to
customers in order to improve the company’s overall profitability.

There is a significant level of judgment involved in estimating the variables used in the
calculation, and it is also important to compare different calculations of CLV made with different
assumptions about profit forecasts and discount rates. CLV is calculated as the net present
value of estimated future profits from the customer for a specified time, which may be three to
five years. Present value is adopted because the profits from the customer are expected to be
generated over a number of years. To obtain a comprehensive and relevant measure of the
value of the customer, CLV considers the company’s expectations about the future potential
growth in profits arising from a customer.

Next advantages are to increased efficiency across the company. The benefits of
weeding out high-maintenance, low-profit customers can be accomplished across the company.
The sales department profits from concentrating its prospecting on the right customers who trust
and pay for the goods and services of the company. Operations and finance should boost
efficiency in serving only those customers who are trusting.

Last but not least, CPA increased efficiency across the company. The benefits of
weeding out high-maintenance, low-profit customers can be accomplished across the company.
The sales department profits from concentrating its prospecting on the right customers who trust
and pay for the goods and services of the company. Operations and finance should boost
efficiency in serving only those customers who are trusting.

5
 6. DISADVANTAGES OF CUSTOMER PROFITABILITY ANALYSIS

The disadvantage of CPA is there here may be practical difficulties in estimating the
costs of each section. The introduction of ABC is also a problem for many businesses due to its
limitation which are cost and benefits. Some argues that, the cost of implementing and
maintaining an Activity Based Costing system can exceed the benefits of improved accuracy. In
addition, If management is not thinking to use ABC information, an absorption costing
system may be simpler to handle. Others claim that ABC is only adopted because it is trendy,
not that it will be used by management to set fair product costs or extra details. Last but not
least, if the costs originate from an operation in real time that is computable in quantitative terms
and can be linked to production efficiency, the cost drivers do not work.

Next, CPA can overlook the combination of customer-purchased products or services.

Profitability of consumers depends on the combination of goods or services purchased. The
danger is that the analysis will be used on specific underperforming products or services, and
will overlook the impact of sales of other products to the customer.

Lastly, Annual profitability may not be representative of the value of the lifetime. The
costs of attracting and retaining the customer should be compared to the lifetime earnings and
not just the annual earnings of the customer. For example, Taco Bell sells tacos for less than $1
each. However, the firm has estimated that a loyal repeat customer generates up to $11,000
over its lifetime [Kotler, 1997].

6
 7. COST INCURRED IN IMPLEMENTING CUSTOMER PROFITABILITY ANALYSIS
(CPA)

In marketing resources comprises of selling department, technical support department,

customer support department, customer service department and sales support department.
Firstly, the department in marketing resources is selling. There are many costs incurred in
selling department which are account executives’ (AE) salaries and benefits, accounts
executives’ (AE) commissions, presentation materials such as brochures, demonstration
facilities expense, travel expenses, entertainment expenses, and last, sales manager’s salary
and benefits. The activities in the selling department are maintaining current customer relations,
generating new customers, making customer presentations to prepare a request for proposal
(RFP) and attending a new product training seminar.

The second department in marketing resources is technical support. Technical support is

referred to a range of services by which enterprises assist users of technology products such as
mobile phones, televisions, computers, software products or mechanical goods. In this
department, cost incurred in implementing CPA is technical design specialists’ (TDS) salaries
and benefits, LD telephone expense, travel expenses, computer costs including software, sales
support or occupancy cost allocation and technical support manager’s salary and benefits. The
technical support activities are to determine the customer’s hardware and software needs and
researching new products.

The third department in marketing resources is customer support. Customer support is a range
of customer services to assist customers in making cost-effective and correct use of a product.
It includes assistance in planning, installation, training, troubleshooting, maintenance,
upgrading, and disposal of a product. In this department, cost incurred in implementing CPA are
customer support representatives’ (CSR) salaries and benefit, automobile expense, travel
expense, LD telephone, sales support or occupancy cost allocation, and customer manager’s
salary and benefits. In addition, training materials are also cost incurred in implement CPA. It is
related to development costs and duplication costs.

Lastly is the department of sales support. Sales support refers to a variety of functions that help
the sales representatives focus on selling and closing deals. This function differs per company,
industry and sales team. There are many costs incurred in sales support department which are
clerical staff’s salaries including benefits, occupancy costs which comprise of a lease and many
more.

7
 8. CHALLENGES IN CUSTOMER PROFITABILITY ANALYSIS (CPA)

Must recognize and estimate future downstream costs of customers

Traditional costing systems match revenues with costs. The usual emphasis is on costs incurred
in the current period or on allocating costs that were capitalized in prior periods. Most systems
pay less attention to capturing the future costs of today’s actions, though progress has been
made with some industries and specialized areas of accounting. Accounting systems now often
recognize as costs of the current period the costs of pensions and medical benefits that will not
actually be paid until much later. Similarly, life insurance accounting recognizes as costs of the
current period outlays for death benefits that will not be paid until future periods. Moreover,
customers with different expected costs in the future are priced differently.

How to include a multi period horizon into the analysis

The importance of having a long-term perspective in business decisions is frequently

emphasized. For example, brand managers need a long-term perspective because some
brands can remain for many years. One challenge in customer profitability analysis is to budget
for and track the profitability of customers over extended periods of time. Several companies
that have experimented with customer profitability reports require sales people to prepare
budgeted sales figures for a three-year horizon beyond the current year for each major
customer. A customer that is unprofitable now and expected to remain unprofitable requires a
different set of corrective actions than a customer that is unprofitable now but expected to be
profitable in the future.

How to recognize different drivers of customer costs

The first generation of customer profitability reports implicitly assumes that all costs are variable
in the long run with respect to the chosen cost drivers and none of the costs are joint. However,
it may lead to more accurate customer profitability reports. For cost management purposes,
customer-line costs and company enterprise costs need not be assigned to individual
customers. Consequently, the company’s total operating income will be less than the sum of
total customer-specific contributions. The resulting challenge is pricing at the customer level
such that customer revenues exceed assigned customer costs and make contribution to
recovering the costs that are not assigned to customers which is customer-line costs and
company enterprise costs cost hierarchies relate to each other.

8
 9. HOW ACTIVITY BASED COSTING CAN IMPROVE THE UNDERSTANDING OF
CUSTOMER PROFITABILITY ANALYSIS

ABC system is a powerful aid to management evaluation and decision-making, thereby

improving organizational performance thus will help company in improving their CPA analysis.
First, ABC can improve understanding of Customer Profitability Analysis by doing process that
focuses on assigning costs and revenues to segments of the customer base, instead of
assigning revenues and costs to the actual products, or the units or departments that compose
the corporate structure of the producer. It is also look from allocation of cost to each type of
customer. This will help to identify which customer type that give profitable for the supplier or
producer. ABC method is by identify accurate overhead cost and cost driver to which is most
need for successful performance of that company. When using ABC, there is process that need
to allocate more resources to profitable activities and eliminate activity or reduce cost that are
costly and wasteful.

CPA allows companies to calculate and understand profitability at the individual customer and
product level and to analyze underlying revenue and cost drivers. It will also help you to
understand which customers and which products are most profitable and therefore critical to
your company. There is important role in ABC because ABC give meaningful information about
the driver of costs, the relationship between cost and product, customer, market and segment.
Other than that, the activities performed in company must be carefully look through.
Furthermore, to provide more detailed and better cost and profitability information, an ABC
analysis enables managers to evaluate processes from an activity viewpoint, leading to
identification of non-value-adding activities and process inefficiencies also if there is cost that
need to be reduce.

An ABC system can sort through these additional overhead costs and help you determine which
customers are actually earning you a reasonable profit. This analysis may result in some
unprofitable customers being turned away, or more emphasis being placed on those customers
who are earning. In addition, ABC mostly used in the manufacturing industry since it enhances
the reliability of cost data, hence producing nearly true costs and better classifying the costs
incurred by the company during its production process and will make the company to earn
largest profits.

9
 10. REAL CASE OF IMPLEMENTATION OF CUSTOMER PROFITABILITY ANALYSIS

There is a real case implementation of customer profitability analysis in the company Federal
Express, Scotland and First union.

For company Federal Express, they have make strategy which is customer who spend a lot of
money but demand little customer service is treated differently than those who spend as much
but cost more to maintain. Company no longer take care to those customers who spend little
and show few sign spending more in the future. This can lead to reduce cost. For analyzed
profitability of 30 large customers that generated 10% of total sales volume and required a lot of
residential deliveries. From this analysis it shows that they just get a little amount of revenue
and had to negotiate discount rate. The company increased rate for some customer and lost
those that do not agree with that rate. In this case Federal Express, they said their focus is not
on customer but more profitable customer. If they want to satisfy customer, they must do it
profitably. Next, they also create new customer for their product and services. For example, they
create overnight package delivery market and is now creating another market for same day
delivery. It makes their customer more satisfy and they can maintain profitability.

Moreover, company Scotland is largest mutual life insurance. This company focused on
customer but not paying attention to profitability of each customer. As a result, they have their
revenues higher but that was not good revenue as there are customer who bought only one
policy and the margins are small. Because instead of attracting affluent customer, its direct mail
marketing campaign was encouraging older couple and stay at home mothers to sign up costly
home visits by sales agents.

10
 11. THE REASON BEHIND THE INCREASED CONCERN OF CUSTOMER PROFIT
ANALYSIS

Management accounting systems often focus on products, departments, or geographic regions,

but not on customers. As a result, companies are often unable to produce reliable per-customer
profitability figures, which leads to keeping unprofitable customers, decreasing company's
potential to make profits. So one of the reason behind the increased concern of Customer Profit
Analysis is the customer profitability can arise from either differences in revenues or differences
in costs. In other words, customer profitability depends not only on the revenue resulting from
sold units of a product or service, but also on the back end services provided, including
marketing, distribution, and customer service.

Next, the other reason is crucially important for continued business success. It measure
customer profitability and helps determine whether certain customers are costing organization
money rather than making organization money. Once organization have a framework in place to
measure this, it becomes easy to analyze customer profitability as frequently as makes sense
for business. The organization may find that a customer group they thought were the most
important is actually of lower value to company than others. These findings can then help shape
and shift company business strategy to keep its initiatives and goals aligned.

Besides, the other reason is to provide to corporate management with the understanding of
each customer profitability. Grouping this information into customer profitability segments,
allows the companies to take different, targeted actions and strategies against different
profitability segments, having as a target increasing the company’s total profitability. Those
companies that understand which customers are more profitable and which are not are armed
with valuable information needed to make successful managerial decision to improve overall
organizational profitability. For example, a company can differentiate customer service activities
depending on customer profile. Highly-profitable customers could receive more attention from
the company to ensure high-level satisfaction and loyalty can be fulfilled in order to protect
continued business relations. Other than that, the company can identify customers’ profile and
also can differentiate marketing strategy and take an action to maintain or increase its customer
profitability.

Lastly, another reason behind the increased concern for customer profitability is global
competition. Company worldwide are being pressured to become more customer focused and
to increasing shareholders value. Customer profitability analysis is a useful tool in both areas.

11
Many companies are convinced that improving corporate profitability requires more customer
contact and closer customer relationships.

CONCLUSION

In conclusion, when viewed as whole, the customer profitability analysis is a technique found in
management accounting literature in recent years, regarding the calculation of profitability of
different customer groups according to the revenues and expenses they generate. For this
reason, this technique is used by companies to measure the contributions and value added by
customers and customer groups. Setting up accounting systems with this philosophy is
important for the accuracy of the analysis and the contributions this analysis will make to
decision making processes.

As a result of this study, the profitability situations of different customer groups were calculated
At the same time, this technique allows the company to have an insight into profitability
per activity apart from cumulative profitability indices. On the other hand, the company must
also consider measures to retain the high profitable customer group, which was the most
profitable, in order to maintain profits in the coming period.

For the companies that have different customer groups ,it will require more detailed
calculations about customer related decisions. Therefore it is necessary to calculate
profitability of customer groups. This is made possible by the customer profitability analysis.
Using the results of the analysis, companies may separate customer groups into segments
according to their contributions and profitability and develop different strategies and decisions
for these segments. Considering the increasing competition in all sectors, the customer
profitability analysis is crucial for all companies, as it provides important data for the
management to take decisions regarding different customer groups. In addition should not
forget that the correct selection of cost system will be used increase the accuracy of the
calculations.

12
REFERENCES

 Customer Profitability Analysis in Accounting (Relevant to ... (n.d.). Retrieved from

http://www.hkiaat.org/e-newsletter/Oct-15/technical_article/PBEII.pdf

 Wilkinson, J. (2019, March 13). 3 Benefits of an Analysis of Customer Profitability.

Retrieved from https://strategiccfo.com/analysis-customer-profitability/

 Team, K. (2017, July 5). Limitations of Activity Based Costing. Retrieved from
https://www.knowledgiate.com/limitations-of-activity-based-costing/

 Will, K. (2020, February 10). What is Activity Based Costing, How Activity Based Costing
Work. Retrieved from https://www.investopedia.com/terms/a/abc.asp

 Customer Profitability Analysis. Jasmin Harvey and Technical Information Service.

January (2009). Step to Implement Customer Profitability Analysis. Retrieved from
https://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_customer_profitabili
ty_analysis_jan09.pdf.pdf (Accessed 01 April 2020)

 Six Steps to Customer Profitability Analysis Jeremy Cox. Retrieved from

https://www.mycustomer.com/marketing/strategy/six-steps-to-customer-profitability-
analysis

 Customer Profitability Definition: How to Measure Customer Profitability Daniel E -.

Retrieved from https://strategiccfo.com/customer-profitability/

 David McNab, President, Exchange Synergism Ltd, What is Customer Profitability and
Why Should We Measure It? Retrieved from https://www.the-
cma.org/disciplines/analytics/archive/what-is-customer-profitability

13