In a world where companies must continually balance centricity with profitability, finding the most profitable customer is just common sense. As a sales leader, you need to know exactly how your customer-focused efforts are paying off – based on a zoomed-out view of the whole customer journey.
Knowing which customers are most profitable – or customer profitability analysis – is an important and ongoing part of running a successful and growing business.
Customer profitability analysis (CPA) helps you dive into the financial realities of each customer relationship, so you can ultimately uncover who truly adds value—and who might be eroding it.
What is Customer Profitability Analysis & Why is it Important?
Customer Profitability Analysis evaluates the revenue and costs associated with individual customers (or segments) to determine their profitability. Unlike a blanket assessment of revenue streams, it digs deeper to account for the expenses tied to serving each customer, such as:
- Acquisition costs (cost of marketing, sales, and onboarding effort)
- Operational costs (associated with customer service, delivery, and technical support)
- Retention costs (cost of loyalty programs, discounts, and perks)
The formula of CPA is simple. It takes into account the revenue you earn from a customer (or segment) and the costs (direct and indirect) associated with it.
Customer Profitability Formula
Customer Profitability = Revenue from Customer − (Direct Costs + Indirect Costs)
To understand how to apply this formula, we’ll need to dive a little deeper.
What are Direct Costs in Customer Profitability Analysis for B2B Businesses?
Direct costs are expenses that you can directly attribute to serving a specific customer. These vary directly with the customer’s activities or consumption. For example, direct costs include:
What are Indirect Costs in Customer Profitability Analysis?
Indirect costs are expenses shared across multiple customers that cannot be traced directly to any one customer. These costs support your overall business operations but aren't linked to a specific customer. Examples include:
An Example Calculation Of Customer Profitability For a SaaS Business.
Let’s take the example of a customer whose annual revenue is $10,000.
Here are the costs to consider for CPA:
Direct Costs:
- Onboarding cost: $1,000
- Support costs: $500
- Hosting/Infrastructure cost for this customer: $600
Total Direct Costs: $2,100
Indirect Costs:
1. Sales and Marketing Spend (prorated):
- Total sales and marketing spend: $50,000
- Total number of customers: 1,000
- Indirect cost per customer for marketing = $50,000 ÷ 1,000 = $50
2. Product Development and R&D (prorated):
- Total product development cost: $200,000
- Total number of customers: 2,000
- Indirect cost per customer for development = $200,000 ÷ 2,000 = $100
3. General Administration and Overhead (prorated):
- Total overhead cost: $100,000
- Total number of customers: 1,000
- Indirect cost per customer for overhead = $100,000 ÷ 1,000 = $100
4. Customer Success (prorated):
- Total cost for customer success programs: $30,000
- Total number of customers: 1,000
- Indirect cost per customer for customer success = $30,000 ÷ 1,000 = $30
Total Indirect Costs per Customer: $50 (Sales & Marketing) + $100 (R&D) + $100 (Overhead) + $30 (Customer Success) = $280
Calculation of Customer Profitability:
- Revenue from Customer: $10,000
- Direct Costs: $2,100
- Indirect Costs: $280
Profitability for the customer = $7,620
Why is Customer Profitability Analysis Important?
As you can see, CPA gives you a true insight into the profitability of your business so you can identify which customers or segments:
- Drive the most profit
- Require further revenue optimization for profitability
- May not be worth continued investment
5 Benefits of Customer Profitability Analysis
The benefits of customer profitability analysis come down to helping sales leaders:
Key Metrics to Uncover from Customer Profitability Analysis
1. Customer Lifetime Value (CLV)
This represents the total revenue a customer generates throughout their relationship with your business.
- Why it matters: It helps to quantify the long-term value of a customer, so you can decide to invest in retaining and nurturing high-value customers. A higher CLV can also justify higher acquisition costs or more personalized services.
2. Cost-to-Serve (CTS)
CTS measures the total direct and indirect costs associated with serving a customer – including everything starting from marketing to delivery to customer support to resource costs and retention.
This means that CTS includes direct and indirect costs.
- Why it matters: CTS provides insight into how much it costs to maintain a customer. If CTS is too close to revenue from a customer, this might be a sign of unprofitability
3. Profit Margin by Customer Segment
This calculates the profitability of different customer groups or segments, to help you understand high-margin customer segments.
- Why it matters: Helps you allocate resources optimally and tailor sales strategies to best serve profitable segments.
4. Retention and Churn Rates
Retention rate is the percentage of customers that continue using your service over a given period. Churn rate refers to the percentage of customers that stop using your service within a given period.
- Why they matter: Both retention and churn rates affect profitability. High retention rates typically lead to higher CLV, while high churn impacts long-term revenue and increases the cost of customer acquisition.
5. Revenue Concentration
This measures the percentage of total revenue that comes from your top customers (Your top customers could be the top one, the top five, or any number of customers based on your business needs).
A high revenue concentration means that a large portion of revenue is dependent on a small group of customers.
- Why it matters: Revenue concentration alerts you to the potential risk of over-reliance on a few customers. As you can imagine, a diverse customer base is less risky.
Key Tools You Need to Perform Customer Profitability Analysis
To do Customer Profitability Analysis effectively, you need a set of tools that support each step of the analysis. Here is a breakdown of the essential tools you need:
1. Customer Relationship Management (CRM) System
CRM tools like Salesforce, HubSpot, or Zoho CRM store essential customer data, such as revenue generation, customer interactions, and engagement metrics.
These tools with their advanced reporting and automation capabilities provide deeper customer insights and integrations with other business systems.
2. Data Collection and Integration Tools
For smaller businesses or simpler data environments, Excel or Google Sheets can manually consolidate customer data from your CRM, accounting system, and other tools.
For larger businesses with more complex data ecosystems, ETL tools like Fivetran, Talend, or Informatica automatically extract, transform, and load data across multiple platforms.
3. Cost Allocation and Attribution Software
You can manually allocate costs (like customer support, fulfillment, etc.) in Excel or Google Sheets. This method works well for small revenue operations with a simple cost structure.
However, dedicated profitability tracking tools like CostPerform, Jedox, Apptio, and others are designed for CPA tracking with automated processes and workflows for the allocation of direct and indirect costs. This can greatly simplify the process of tracking specific customer-related costs like support hours, custom product development, or marketing efforts.
4. Data Analysis and Business Intelligence (BI) Tools
When your data sets are manageable, and you only need basic calculations and visualizations. Google Sheets or Excel with built-in formulas can help with basic analysis, such as calculating Cost-to-Serve (CTS) or Customer Lifetime Value (CLV) and profitability by customer segment.
If you’re looking for more advanced, automated tools for lifetime value and profitability metrics, you can use tools likeProfitWell provide built-in CLV calculators and customer segmentation tools that help businesses better understand the financial impact of different customers.
Tableau, Power BI, or Looker are powerful BI platforms that allow you to visualize and interact with data in real time, helping you analyze profitability trends, segment customers, and identify actionable insights.
A Step-by-Step Guide to Conducting Customer Profitability Analysis (CPA)
With an understanding of the right tools you need, here’s a detailed guide on how to implement CPA in a structured, step-by-step approach:
Step 1: Collect Customer Data
Use your CRM (e.g., Salesforce, HubSpot) to pull data on individual customers or customer segments. This includes information on revenue, usage, and interactions with your business.
Extract data from your CRM into Excel or Google Sheets for analysis. For more advanced data operations, an ETL (extract, transform, load) tool like Fivetran automatically syncs data from multiple systems (CRM, accounting, support tools, etc.) into a centralized repository.
Step 2: Allocate Costs
Allocation tools automate the allocation of shared expenses across customer segments. Here are some guidelines:
1. Allocation of Direct Costs: Attribute direct costs to the customer based on actual usage or activities. For instance:
- If a customer receives 20% of your total customer support hours, allocate 20% of your total support costs to that customer.
- If a customer’s usage of your service represents 15% of your total cloud storage, assign 15% of hosting costs to that customer.
2. Allocation of Indirect Costs: Indirect costs are trickier to allocate because they are shared across many customers. You can use various methods to allocate indirect costs:
- Pro-rata method: Allocate costs based on the proportion of revenue or usage. For example, if a customer generates 5% of total revenue, they would be assigned 5% of marketing or R&D costs.
- Customer count method: Divide indirect costs equally among all customers if each customer benefits equally from the expense.
- Usage-based method: For infrastructure or platform costs, assign costs based on actual usage (e.g., hours spent on the platform or server resources consumed).
Use your CRM and accounting data for direct cost allocation. You can use any spreadsheet to input and allocate costs manually or use tools like CostTracks or Apptio to automate the allocation of direct and indirect costs.
Step 3: Calculate Profitability Metrics
Now that costs have been allocated, you can apply the CPA formula for each customer or segment, to arrive at metrics like:
- Customer Profit Margin per customer
- Customer Lifetime Value (CLV) per customer and segment
- Cost to Serve per customer and segment
- Retention and churn rate per segment
Step 4: Slice and Dice Profitability Metrics
Segment your customers based on profitability metrics such as CLV, CTS, and churn rates. This will help you identify high-value customer segments and optimize resource allocation.
Use Excel pivot tables to segment and analyze customer profitability. Or you could use Power BI or Looker to create dynamic, interactive segmentation reports that track:
- Profit margin
- Retention and churn
- Revenue concentration
Step 5: Refine, Validate, and Use Your Insights
Once you’ve analyzed your data, you can use the insights to make business decisions about customer retention, pricing, and acquisition strategies.
- Identify High- and Low-Value Customers: Look for customers or segments that generate the most profit. Identify customers who are either unprofitable or marginally profitable. This may highlight areas where resources are being wasted, or pricing adjustments may be needed.
- Look for Patterns: Identify the common characteristics among profitable customers. This could include customer size, industry, usage patterns, or service preferences.
In addition, look for patterns among unprofitable customers to understand what drives costs (e.g., high support needs or under-utilization of services).
While a revenue intelligence tool like Gong or MeetRecord isn’t typically included in the traditional CPA process, it can add significant value to your analysis by enriching it with qualitative insights from customer conversations.
For instance, MeetRecord’s Revenue Intelligence capabilities can validate findings from your CPA by helping you in:
- Analyzing Customer Interactions: Use MeetRecord to analyze call and meeting data with customers. Its AI can help identify themes or issues in customer conversations that might explain profitability trends.
- Identifying Retention Risks: If customers express dissatisfaction or show signs of disengagement in meetings, this can indicate potential churn, which should be reflected in your CPA analysis.
These insights can help you prioritize follow-up actions, such as refining customer support or adjusting pricing strategies, based on real customer conversations. In other words, a revenue intelligence tool can be a powerful addition to your customer profitability analysis process – it can help you dig deeper into the "why" behind customer behavior.
To know more about how revenue intelligence can help with customer profitability analysis, sign up for a live demo with our experts.
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