Customer profitability analysis is allocation revenues and cost to an individual customer to enable calculation of profit of each customer (Van 2005 pg.3). Customers can be evaluated and categorized as profitable and unprofitable depending on their characteristics. The traits are based on certain expenses incurred as a result of specific customer actions such discounts allowed, agent commissions, cost of field services and cost of sales support (Smith 1995 pg.3). Also, sales credits, debtor collection period and order processing discounts are considered.
Customer profitability analysis is more accurate when using activity-based costing (Noone 1997 pg.2). The services done to the customers are compared to the revenues gathered from the client and other cases, qualitative advantages from the client. The analysis of Pro ltd Customer code pro-1 show that, has many orders of 180 times during the financial period with each order costing $350 hence the total amount of sales order is $63000. Costs for field visits is $ 4200, charges of normal deliveries are $ 508, and the cost of urgent deliveries is $ 12320. The average collection period is 60 days, and the number of normal distributions is 100 per period. Customer code pro-1 has an annual revenue of $1650000 and a profit margin of $98,000.
Customer pro-2 has sales order cost of $19,950, cost of sales visit at $2,100, the cost of normal deliveries is $189, and urgent deliveries cost $2,240. The average collection period is 45 days, and the number of normal distributions is 32. The recorded annual revenue from customer code pro-2 is $785,000 while operating profit is $83,000. From the information provided, the major cost drivers are the number of sales orders, urgent deliveries, and the number of field visits and routine of normal distributions. The profitability of the customers is dependent on costs incurred on the cost drivers as a result of changes in the units (Searcy 2004 pg. 51). Customer code pro-1 has higher costs because of higher numbers of sales order, sales field visits, normal deliveries, urgent deliveries, longer distance and more collection period. Customer code pro-2 has lower costs compared to pro-1 as has smaller sales orders, number of visits, shorter length and fewer urgent deliveries and regular deliveries. For strategic revenue management of the management, several measures should be taken to minimize the costs for the yield of higher operational profits. The number of deliveries should be restructured to be timelier and less frequent to each customer. It will reduce the amount of urgent and normal deliveries which have high costs. The field visit should be well scheduled and revision of debts payment period done to save on service delivery costs for higher profits.
Pro ltd realizes that it is important to maintain a good quality-profit linkage in its contracts. Discuss the concept of quality-profit linkage and critically evaluate the extent to which the Cost of Quality (CoQ) model is useful to sustain such linkage.
As many companies do, Pro ltd promotes central customers' value in achieving competitiveness in the market. Smith and Dikolli (1995) analyzed activity-based costing and how it affects the outcome of strategic decision making for companies. They observed that customers' related costs could lead to change in cost-effective, especially in the ways customers get satisfied. For Pro ltd quality has become the fore figure to gain a relative position of the company. The above data analysis shows that it has strived towards achieving a better place in the market.
Notably, Pro ltd from the data, operating revenue from the company, dropped with a significant figure. The drop could have been as a result of systematic approaches deployed by the company in addressing customer value issues. Kaplan and Norton (2016) reported some of the routine methods, including customer segmentation, measuring profitability, and estimating lifetime value. First, customer segmentation includes the process of dividing customers into groups for decision making. Secondly, customers' lifetime value is a new dimension for understanding the value for customers and reflects them to the present value and future flows associated with the customer (Kaplan and Norton, 2016 pg 7).
Measurement of the cost of quality is the first step in the quality management program (Tsai, 1998). An appropriate Total Quality Management (TQM) leads to high process and outputs. At the end of the process, more significant customer satisfaction is improved and profitability (Campatelli et al., 2011). For most manufacturing and marketing, quality management has been a critical issue over the past years (Sjoblom, 1998).
Profit usually varies from product to another (Sievanen et al., 2004). Not all products produced by the company would bring profit in the short run. However, the management has a role to play in making appropriate decisions taking cost perspective into account. Sievanen et al. (2004) analysis noted that only 40% of a company's customers are profitable and generate 250% of the profits. 10% of the customers account for 120% of the loss in profits (Sievanen et al., 2004). The degree of profitability for every customer supports better decisions making for a company. Profitability distribution yield information about the vulnerability of future cash flows from the customers (Van Raaij, 2005). Quality profit linkage relies on costs and revenues, risks, and strategic positioning of the company (Van Raaij, 2005).
The cost of the quality model affects the company's performance with the quality systems. An ABC analysis helps management derive the appropriate information that could provide insight into the actual profitability and the cost of quality (Noone and Griffin, 1997). Ball (2006) reported that it is often for companies to declare customer satisfaction when they want to deliver a financial return. To obtain an optimal level of investment, a company needs to conduct appraisal activities to improve customer satisfaction (Ball, 2006). The cost of the quality model would sustain these quality profit linkages by, first, improving the reliability hence increasing customers' satisfaction at the point of diminishing returns. Secondly, determine the levels to optimize financial and customer comfort (Ball, 2006). Thirdly, the company must align the goals setting process for the business and quality metrics. Finally, the company must control its budgetary forecasts, mainly on financial impact and quality improvement goals (Ball, 2006).
Schiffauerova and Thomson (2006) found that the CoQ model is not utilized in most quality management programs. Their study concluded that those companies that do not adopt CoQ methods are successful in reducing quality costs as well as improving quality for their customers (Schiffauerova and Thomson, 2006).
Smith, M., & Dikolli, S. (1995). Customer profitability analysis. Managerial Auditing Journal.Kaplan, R. S., & Norton, D. P. (2016). The balanced scorecard: an excerpt from the CGMA book'Essential Tools for Management Accountants'. Journal of Accountancy, 221(5), 39-42.
Sjoblom, L. M. (1998). Financial information and quality management--Is there a role for accountants?. Accounting Horizons, 12(4), 363.Sievanen, M., Suomala, P., & Paranko, J. (2004). Product profitability: causes and effects. Industrial Marketing Management, 33(5), 393-401.
Van Raaij, E. M. (2005). The strategic value of customer profitability analysis. Marketing Intelligence & Planning.van Raaij, E. M., Vernooij, M. J., & van Triest, S. (2003). The implementation of customer profitability analysis: A case study. Industrial marketing management, 32(7), 573-583.Noone, B., & Griffin, P. (1997). Enhancing yield management with customer profitability analysis. International Journal of Contemporary Hospitality Management.Ball, S. (2006). Making the cost of quality practical. Strategic Finance, 88(1), 34.Schiffauerova, A., & Thomson, V. (2006). A review of research on cost of quality models and best practices. International Journal of Quality & Reliability Management.Tsai, W. H. (1998). Quality cost measurement under activitybased costing. International Journal of Quality & Reliability Management.Campatelli, G., Citti, P., & Meneghin, A. (2011). Development of a simplified approach based on the EFQM model and Six Sigma for the implementation of TQM principles in a university administration. Total Quality Management & Business Excellence, 22(7), 691-704.
Searcy, D.L., 2004. Using activity-based costing to assess channel/customer profitability: better understanding of your customers' profitability picture is imperative for survival in today's competitive environment. Here the CFO of an employment services company used ABC to analyze the company's profitability picture at the customer channel-and individual customer-level. Management Accounting Quarterly, 5(2), pp.51-51.
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