As your business grows, your client diversity grows with it. Each type of client will most likely interact with your business in different ways, whether it’s in the form of a unique project, tailored offerings based on their needs, or various timelines.
With this comes multiple types of revenue and differing resource requirements — meaning you have multiple profit categories and a need for a customer profitability analysis.
Let’s walk through what exactly a customer profitability analysis looks like, how to conduct one, and how it can boost your business efficiency.
What is customer profitability?
A customer profitability is exactly what it sounds like: a measurement of how profitable a specific client is. It compares how much revenue a client generates to how much you spent in resources — both expenses and time — to acquire or even retain the client.
Here’s an example: Let’s say you’re running a content marketing firm and have two separate clients, Sam and Susan. Sam is loyal and likes to utilize your services in bulk — your team builds his quarterly content pieces all at once, and there’s rarely an issue. He doesn’t ask for a lot of meetings, and rarely needs more than one edit for each piece.
Susan, on the other hand, is also loyal and pays for the same amount of content, but likes to order in smaller, “a la carte” quantities. For most pieces of content, she requires multiple edits, likes to jump on unplanned calls to ask questions or provide feedback, and even requests items that weren’t in the original order on a regular basis.
One of these clients is more profitable than the other in the long run — while both are loyal, you’ll likely make more money from Sam if the relationship continues as is.
Why is it important?
If you understand which clients result in the most profit for your firm, you can make better business decisions for your organization as a whole.
Conducting a customer profitability analysis thoroughly can help you create a more efficient sales strategy because you’re able to segment your client base, identify the best opportunities, and customize your sales efforts to win those opportunities. This way you’re focusing on landing the clients that are most likely to boost your bottom line.
Choosing a customer profitability analysis formula
While a complete customer profitability analysis is detailed, full of insights, and a bit labor-intensive as a result, there are a couple of formulas that can give you a rough idea of how much you make off different clients.
Customer Lifetime Value
A Customer Lifetime Value (CLV) formula gives you the net profit of a client over the length of their relationship with your firm. It doesn’t include any additional costs outside of what it costs to acquire the client, and it doesn’t provide a lot of insights into what you could potentially gain in the future or why they’ve stayed with you for as long as they have.
Still, it gives you a rough forecast of where the relationship could lead and is useful if you want to understand how much revenue they’ve generated and might generate in the future.
Here’s what it looks like:
(Annual profit per customer X number of years spent as a customer) — Cost of initial customer acquisition = CLV
Average Revenue per User
The Average Revenue per User (ARPU) formula tells you how much revenue you’re generating from different buckets of clients that subscribe to a certain service or fit a certain type. It doesn’t necessarily predict client behavior, and doesn’t provide any insights on profit.
However, it can be a nice starting point for figuring out your customer profitability and can help you understand if your current initiatives are performing well.
Here’s what it looks like:
Total revenue/Total number of subscribers within a persona = ARPU
How to conduct a customer profitability analysis
While the formulas above provide some rough intel, it’s best to perform a full customer profitability analysis to truly understand the value of your clients. Here’s how to do it in three steps.
Step 1. Identify your touchpoints
To start, conduct an audit of each touchpoint your clients have with your firm — and make sure you address each one thoroughly.
Different touchpoints can include:
- Social media
- Paid marketing campaigns
- Customer service
Then, calculate the exact cost of each touchpoint, and prioritize them based on their expense and ROI. Doing this will help ensure you’re focusing your efforts and resources in the most profitable channels.
Step 2. Segment your client base
One of the easiest ways to segment your client base is to use buyer personas, or a detailed description of someone who represents your ideal client based on market research and your existing client base. Then you can separate your customers into each buyer persona bucket and analyze profitability based on their behavior and background.
Want to segment clients even further? Conduct an RFM analysis:
- Recency: How recently did the client make a purchase? If it was recently, they have a high likelihood of buying again. If not, you might need to put them back into your nurture campaign.
- Frequency: How often does the client make purchases? If it’s often, you’re aware of their behavior. But if they made a one-time purchase, you might consider sending them a customer satisfaction survey.
- Monetary Value: How much do they spend? It’s not entirely about the number here, but you can use it to understand the first two factors more clearly.
Step 3: Determine how much each segment costs (and spends)
The next step is to determine which data is relevant to understanding customer profitability for each segment. If you want to see how much each persona spends on and costs your business, you should be able to find that data in your income statements.
Identify the average cost per transaction for each buyer persona, and compare it with the same persona’s average revenue per transaction. Then you’ll be able to calculate each segment’s profitability and identify which of them result in the most value for your firm — allowing you to make better decisions on how to allocate your resources.
It’s important to note that customer profitability metrics shouldn’t be used to dictate your business operations in totality — every client should receive the best customer service at all times. But, understanding which clients are the most valuable gives you even more insight to refer back to when structuring your sales and marketing efforts.