ses and matching them to the revenue groups, keep in mind several things that can meaningfully impact the profitability of any customer group and ultimately the total profit of your business. The number of customers in each group is important, because some of your expenses will be related to this. For example, shipping and handling is partly driven by the number of customers that you ship to. The number of new, versus repeat buyers is key, because you really don't need to spread as much sales and marketing expense to the "old" customers as you are to the "new" ones. There may be costs related to a particular group for sales and marketing, or fulfillment. Fixed, versus variable costs are important, because you benefit from spreading fixed costs over as many customers as possible, while variable costs can rise or fall based on the number of customers that you service. And, finally, don't neglect to consider time you and you staff have to spend servicing customers. Salary expenses are fixed in total (at least in the short term), but the amount of time that a customer demands can vary greatly and in that sense can be "hidden" costs as you look at the profitability of any customer.

If you are so incl

Do you have any idea how much your customers are actually worth to you? Do you know which ones you make money on and the financial impact of those that beat you up over price, service levels and "extras?" Or, do you say things like "we don't have the time to figure that out," - or, "we are different," - or, "how would knowing that really help us" - etc, etc?

What could be more relevant to any small business than having at least a basic understanding of customer profitability? Usually when a company looks honestly at its customers, the realization jumps off the page that you make a lot of money from some customers, you make less on another group, and you probably lose money on some. When you think in terms of the factors that drive this in your company, you can begin to take steps to make sure you retain the profitable ones and not spend too much of your time on the others.

There are several ways to look at customer profitability, but one of the best is to think in terms of the lifetime value of an individual customer. Lifetime customer value (LCV) is the amount of profit that you will realize from an individual customer over the time that that customer does business with you. Focusing on LCV gets you two things. First, it measures the profitability of your customers, not just the revenue, and, because there can be a big difference in margin and costs between customers, the amount of money you make can be very different. Second, LCV focuses on your overall, long-term relationship with customers, not recent transactions, and over time some relationships have the potential to be a lot more valuable than others.

The challenge, of course, is that when you start thinking about how to implement this concept, you quickly realize that it can be expensive and time consuming to collect the information you need to really impact your bottom line. But, what if you could get "80%" of the benefit of knowing the LCV of your customers for "20%" of the investment? Wouldn't you be willing to spend a few hours and maybe do a little tracking and forecasting, if it would make you more profitable? Here are some things you can do.

Start by creating a list of characteristics that describe both your ideal customers and your less than ideal customers. The objective is to identify both the quantifiable and the intangible factors that influence the profitability of an individual customer. For example, a long time customer, or a customer that makes multiple purchases, is better than a new one, for the obvious reason that it gives you a bigger revenue stream and the not so obvious reason that it doesn't cost you as much to market, sell to, and service that customer. A customer that has been in business for awhile, or buys higher margin products, or refers other business to you, or who you can use as a reference is a lot more valuable to you than one who is always pushing you on price, or takes up a lot of your time, or who requires that you stock inventory that you otherwise wouldn't, or who is just generally difficult to deal with. The more that you can quantify in describing these customers the better; but the intangibles are important, too, because there are hidden costs involved.

Then divide customers into 3, or 4 revenue groups. You can refine this later, if you want to, but you need a starting point. One place to begin is some combination of number of purchases, average sale amount, or total sales per customer. Looking at number and dollars of sales splits your customer base either by revenue (dollars), or activity (number). These are two of the important things that drive profitability.

Sometimes a better place to start, if you have the information, would be 3, or 4 divisions based on gross profit margin, or some other key profit driver. If you don't know gross profit margin by customer, you could divide your customer base by number, or dollars of sales, look at the margin for a few representative customers in each group, and make some assumptions about the margin for the entire group. The value of an initial division by gross profit margin is that you have already made a big profitability distinction in grouping your customers.

Finally, look at your expenses a little differently and break them into 4 categories. These 4 expense categories are cost of goods sold (the cost of making or buying the product you sell), sales and marketing (the cost to get and keep your customers), fulfillment (the cost to deliver your product to customers), and general and admin (everything else). A few assumptions have to be made here and in some cases you might have to split an expense between more than one of the four categories. But, once you've done this, you can look at your expenses in a different way - i.e. how they are affected by individual customer transactions.

In restating expenses and matching them to the revenue groups, keep in mind several things that can meaningfully impact the profitability of any customer group and ultimately the total profit of your business. The number of customers in each group is important, because some of your expenses will be related to this. For example, shipping and handling is partly driven by the number of customers that you ship to. The number of new, versus repeat buyers is key, because you really don't need to spread as much sales and marketing expense to the "old" customers as you are to the "new" ones. There may be costs related to a particular group for sales and marketing, or fulfillment. Fixed, versus variable costs are important, because you benefit from spreading fixed costs over as many customers as possible, while variable costs can rise or fall based on the number of customers that you service. And, finally, don't neglect to consider time you and you staff have to spend servicing customers. Salary expenses are fixed in total (at least in the short term), but the amount of time that a customer demands can vary greatly and in that sense can be "hidden" costs as you look at the profitability of any customer.

If you are so incli

CV gets you two things. First, it measures the profitability of your customers, not just the revenue, and, because there can be a big difference in margin and costs between customers, the amount of money you make can be very different. Second, LCV focuses on your overall, long-term relationship with customers, not recent transactions, and over time some relationships have the potential to be a lot more valuable than others.

The challenge, of course, is that when you start thinking about how to implement this concept, you quickly realize that it can be expensive and time consuming to collect the information you need to really impact your bottom line. But, what if you could get "80%" of the benefit of knowing the LCV of your customers for "20%" of the investment? Wouldn't you be willing to spend a few hours and maybe do a little tracking and forecasting, if it would make you more profitable? Here are some things you can do.

Start by creating a list of characteristics that describe both your ideal customers and your less than ideal customers. The objective is to identify both the quantifiable and the intangible factors that influence the profitability of an individual customer. For example, a long time customer, or a customer that makes multiple purchases, is better than a new one, for the obvious reason that it gives you a bigger revenue stream and the not so obvious reason that it doesn't cost you as much to market, sell to, and service that customer. A customer that has been in business for awhile, or buys higher margin products, or refers other business to you, or who you can use as a reference is a lot more valuable to you than one who is always pushing you on price, or takes up a lot of your time, or who requires that you stock inventory that you otherwise wouldn't, or who is just generally difficult to deal with. The more that you can quantify in describing these customers the better; but the intangibles are important, too, because there are hidden costs involved.

Then divide customers into 3, or 4 revenue groups. You can refine this later, if you want to, but you need a starting point. One place to begin is some combination of number of purchases, average sale amount, or total sales per customer. Looking at number and dollars of sales splits your customer base either by revenue (dollars), or activity (number). These are two of the important things that drive profitability.

Sometimes a better place to start, if you have the information, would be 3, or 4 divisions based on gross profit margin, or some other key profit driver. If you don't know gross profit margin by customer, you could divide your customer base by number, or dollars of sales, look at the margin for a few representative customers in each group, and make some assumptions about the margin for the entire group. The value of an initial division by gross profit margin is that you have already made a big profitability distinction in grouping your customers.

Finally, look at your expenses a little differently and break them into 4 categories. These 4 expense categories are cost of goods sold (the cost of making or buying the product you sell), sales and marketing (the cost to get and keep your customers), fulfillment (the cost to deliver your product to customers), and general and admin (everything else). A few assumptions have to be made here and in some cases you might have to split an expense between more than one of the four categories. But, once you've done this, you can look at your expenses in a different way - i.e. how they are affected by individual customer transactions.

In restating expenses and matching them to the revenue groups, keep in mind several things that can meaningfully impact the profitability of any customer group and ultimately the total profit of your business. The number of customers in each group is important, because some of your expenses will be related to this. For example, shipping and handling is partly driven by the number of customers that you ship to. The number of new, versus repeat buyers is key, because you really don't need to spread as much sales and marketing expense to the "old" customers as you are to the "new" ones. There may be costs related to a particular group for sales and marketing, or fulfillment. Fixed, versus variable costs are important, because you benefit from spreading fixed costs over as many customers as possible, while variable costs can rise or fall based on the number of customers that you service. And, finally, don't neglect to consider time you and you staff have to spend servicing customers. Salary expenses are fixed in total (at least in the short term), but the amount of time that a customer demands can vary greatly and in that sense can be "hidden" costs as you look at the profitability of any customer.

If you are so incl

long time customer, or a customer that makes multiple purchases, is better than a new one, for the obvious reason that it gives you a bigger revenue stream and the not so obvious reason that it doesn't cost you as much to market, sell to, and service that customer. A customer that has been in business for awhile, or buys higher margin products, or refers other business to you, or who you can use as a reference is a lot more valuable to you than one who is always pushing you on price, or takes up a lot of your time, or who requires that you stock inventory that you otherwise wouldn't, or who is just generally difficult to deal with. The more that you can quantify in describing these customers the better; but the intangibles are important, too, because there are hidden costs involved.

Then divide customers into 3, or 4 revenue groups. You can refine this later, if you want to, but you need a starting point. One place to begin is some combination of number of purchases, average sale amount, or total sales per customer. Looking at number and dollars of sales splits your customer base either by revenue (dollars), or activity (number). These are two of the important things that drive profitability.

Sometimes a better place to start, if you have the information, would be 3, or 4 divisions based on gross profit margin, or some other key profit driver. If you don't know gross profit margin by customer, you could divide your customer base by number, or dollars of sales, look at the margin for a few representative customers in each group, and make some assumptions about the margin for the entire group. The value of an initial division by gross profit margin is that you have already made a big profitability distinction in grouping your customers.

Finally, look at your expenses a little differently and break them into 4 categories. These 4 expense categories are cost of goods sold (the cost of making or buying the product you sell), sales and marketing (the cost to get and keep your customers), fulfillment (the cost to deliver your product to customers), and general and admin (everything else). A few assumptions have to be made here and in some cases you might have to split an expense between more than one of the four categories. But, once you've done this, you can look at your expenses in a different way - i.e. how they are affected by individual customer transactions.

In restating expenses and matching them to the revenue groups, keep in mind several things that can meaningfully impact the profitability of any customer group and ultimately the total profit of your business. The number of customers in each group is important, because some of your expenses will be related to this. For example, shipping and handling is partly driven by the number of customers that you ship to. The number of new, versus repeat buyers is key, because you really don't need to spread as much sales and marketing expense to the "old" customers as you are to the "new" ones. There may be costs related to a particular group for sales and marketing, or fulfillment. Fixed, versus variable costs are important, because you benefit from spreading fixed costs over as many customers as possible, while variable costs can rise or fall based on the number of customers that you service. And, finally, don't neglect to consider time you and you staff have to spend servicing customers. Salary expenses are fixed in total (at least in the short term), but the amount of time that a customer demands can vary greatly and in that sense can be "hidden" costs as you look at the profitability of any customer.

If you are so incl

Sometimes a better place to start, if you have the information, would be 3, or 4 divisions based on gross profit margin, or some other key profit driver. If you don't know gross profit margin by customer, you could divide your customer base by number, or dollars of sales, look at the margin for a few representative customers in each group, and make some assumptions about the margin for the entire group. The value of an initial division by gross profit margin is that you have already made a big profitability distinction in grouping your customers.

Finally, look at your expenses a little differently and break them into 4 categories. These 4 expense categories are cost of goods sold (the cost of making or buying the product you sell), sales and marketing (the cost to get and keep your customers), fulfillment (the cost to deliver your product to customers), and general and admin (everything else). A few assumptions have to be made here and in some cases you might have to split an expense between more than one of the four categories. But, once you've done this, you can look at your expenses in a different way - i.e. how they are affected by individual customer transactions.

In restating expenses and matching them to the revenue groups, keep in mind several things that can meaningfully impact the profitability of any customer group and ultimately the total profit of your business. The number of customers in each group is important, because some of your expenses will be related to this. For example, shipping and handling is partly driven by the number of customers that you ship to. The number of new, versus repeat buyers is key, because you really don't need to spread as much sales and marketing expense to the "old" customers as you are to the "new" ones. There may be costs related to a particular group for sales and marketing, or fulfillment. Fixed, versus variable costs are important, because you benefit from spreading fixed costs over as many customers as possible, while variable costs can rise or fall based on the number of customers that you service. And, finally, don't neglect to consider time you and you staff have to spend servicing customers. Salary expenses are fixed in total (at least in the short term), but the amount of time that a customer demands can vary greatly and in that sense can be "hidden" costs as you look at the profitability of any customer.

If you are so incl

ses and matching them to the revenue groups, keep in mind several things that can meaningfully impact the profitability of any customer group and ultimately the total profit of your business. The number of customers in each group is important, because some of your expenses will be related to this. For example, shipping and handling is partly driven by the number of customers that you ship to. The number of new, versus repeat buyers is key, because you really don't need to spread as much sales and marketing expense to the "old" customers as you are to the "new" ones. There may be costs related to a particular group for sales and marketing, or fulfillment. Fixed, versus variable costs are important, because you benefit from spreading fixed costs over as many customers as possible, while variable costs can rise or fall based on the number of customers that you service. And, finally, don't neglect to consider time you and you staff have to spend servicing customers. Salary expenses are fixed in total (at least in the short term), but the amount of time that a customer demands can vary greatly and in that sense can be "hidden" costs as you look at the profitability of any customer.

If you are so inclined, you can bring these assumptions together in a financial model that lets you forecast LCV with some precision. But, consider what you have learned already by taking these few steps. You're recognizing in a more focused, analytical way, that not all customers are the same. You see more clearly that the amount of sales to a customer is not all that matters. The margin is a lot higher for some customers that for others. Your company's expenses take on a different meaning, because they now generally reflect what it costs you to get, keep, and service your customers. You're thinking in terms of some of the key factors that impact the profitability of any of your customers. If you stop here, you have spent a few hours of your time, but you still have benefited from understanding more about how much you might make, or lose, from different groups of customers.

(There are two Business Management Tools on the Business Advisor Online site that will help you easily gain a financial perspective on the Lifetime Customer Value of your customers. The Simple Calculation LCV Model provides a high level calculation; it does not require you to have collected detailed customer information, but will still give you a reasonable LCV estimate. The Detailed Calculation LCV Model lets you include more information in the calculation and helps to estimate expenses in the four categories outlined in this week’s feature article.)