Some of Your Customers Are Costing You Money

What they were looking at

What does it really cost to serve each of your customers? Robert Kaplan, the Harvard accounting professor who developed activity-based costing with Robin Cooper, spent years helping companies work that out. That meant the cost of the product, and also the orders, deliveries, support calls, custom terms and account management each customer used up.

Once those costs are assigned customer by customer, you can rank every customer from most to least profitable and keep a running total of profit as you go down the list.

What they found

You’d expect the running total to climb smoothly to 100%. It doesn’t. It shoots past 100%, flattens out, then falls back to 100% at the end of the list, because the customers at the bottom lose money. Plot it and it looks like a whale breaking the surface, which is where the name comes from.

“The shape of the curve in Figure 1 occurs in virtually every customer profitability study ever done” Kaplan, “A Balanced Scorecard Approach to Measure Customer Profitability,” HBS Working Knowledge, August 8, 2005

In the example he describes,

“the most profitable 40 percent of customers generate 130 percent of annual profits” Same

The middle 55% break even, and the least profitable 5% lose the equivalent of 30% of profits. Looking across studies, the Institute of Management Accountants, citing Kaplan and Narayanan, puts the usual range even wider.

“Typically, about 20% of customers generate anywhere from 150% to 300% of company profits” IMA, Statement on Management Accounting: Customer Profitability Management (2010), p. 2

By the IMA’s account, the bottom tenth of customers can destroy anywhere from 50% to 200% of profits.

What it means

In revenue, the power law shows up as a minority of accounts making up a majority of the results. In profit it gets sharper. The tail is small to begin with, and once you count what it takes to serve those customers, part of it is actually costing you money.

So you can grow your customer count, your revenue and your costs all at once and still watch profit fall, because the growth came in at the wrong end of the curve.

Where it shows up in a revenue team

• Cost per acquisition counts the cost to win a customer. It doesn’t count the cost to serve one, and the whale curve is what happens after the sale.
• High-touch, low-value accounts (custom terms, heavy support, small orders) sit at the far end of the curve.
• Check what the cheapest customers cost to serve. Kaplan traced unprofitable customers to small orders, custom work, rush delivery and heavy support, not to how they were won, so whether your cheapest channel fills the tail is yours to measure.
• Tier on contribution where you have it. Only a large customer can be a large loss, so a tier built on revenue alone can put a loss-maker at the top.
• So do you fire the customers at the bottom? No. Find out which ones you’re paying to acquire more of, and stop paying for those.