Customer profitability: is the customer king - or cost? - CEO Insights

Chief Executive, The, April, 2003

Consumer products companies compete fiercely for the business of large retailers. Customer profitability analysis can ensure that those efforts deliver positive return on investment.

WHEN WAL-MART BECAME THE WORLD'S LARGEST COMPANY LAST year, the achievement reflected a decades-long trend in the U.S. economy away from manufacturing toward services. Yet there was an additional implication for consumer products companies that serve large retailers: Increasingly, such customers wield greater individual influence over the balance sheet.

It's no surprise, then, that corporate leaders of consumer products companies are more carefully scrutinizing their relationships with trade customers. In particular, they're weighing the cost to serve those customers against the resulting revenue. The goal is to uncover strategies for making each customer more valuable while ensuring a lasting, mutually beneficial relationship.

It's the latest incarnation of customer profitability, a concept that began to take hold a decade ago among financial services providers and other organizations that directly serve consumers. The idea is to provide higher levels of service to customers that deliver greater profits -- and upsell or even shed customers on the lower rungs of profitability. Although few have perfected it, the approach is becoming mainstream as executives recognize the value of a strong customer focus.

"The cost to retain existing customers is far lower than the cost to attract new ones," points out Kimberly Collins, Ph.D., a research director for Gartner in Stamford, Conn. "So smart companies are investing in ways to identify and better serve their most valuable customers."

Now, executives at consumer products companies are taking the same approach to their trade customers. They're developing strategies to analyze customer profitability to determine the total cost to serve each customer, identify ways to reduce those costs and take actions that ensure every customer relationship is as profitable as it can be.

The Cost to Serve

There are good reasons for this sharper focus on customer profitability. "During the past several years, consumer products companies have been increasing their trade spend, providing new services to trade customers and incurring greater costs to serve them," says Marc Shingles, customer profitability solution/practice leader for Cap Gemini Ernst & Young U.S. LLC (CCE&Y). "Much of this activity has been driven by competitive pressures as manufacturers strive to build more solid relationships with large retailers."

It started with services such as vendor-managed inventory. In exchange for point-of-sale data, manufacturers helped retailers optimize inventory levels and automate replenishment.

Manufacturers captured valuable information about consumer behavior, ensured that their products were always in stock and differentiated themselves from less sophisticated competitors. They also incurred tremendous cost. And as large retailers began requiring vendor-managed inventory of all manufacturers, the competitive advantage dwindled.

At LeapFrog Enterprises, a maker of interactive learning products, building relationships with its retail partners is critical to the company's growth -- net profits for the Emeryville, Calif., upstart increased a whopping 349 percent to $43 million last year, on a 69 percent sales increase to $532 million.

"We look at our partnerships with retailers over the long term," says Michael Wood, LeapFrog's founder and CEO. "We monitor on a weekly and sometimes a daily basis the sales of our major retail partners, their in-stock position, their margin, their inventory, their turns. We monitor our profitability and their profitability very closely, because the relationship has to be strong on both sides."

"The strength of that partnership determines how many opportunities our ultimate customers -- moms and dads and teachers and kids -- will have to buy LeapFrog products," Wood adds.

The better the relationship with the retail customer, the more likely the company is to understand the particulars behind the sale -- and the potential areas for savings. Consider the display-ready pallets many companies use. According to CGE&Y, end-of-aisle product displays were formerly an activity (and expense) of the retailer but are now assembled by the manufacturer in its distribution centers. This reduces cost and hassle for the retailer while ensuring prime shelf space for the manufacturer. But it also can involve millions of dollars in additional expenditure transferred from the retailer to the manufacturer.

Equally costly are customer-specific product configurations and marketing activities. Increasingly, retailers rely on manufacturers to deliver exclusive products that enable retailers to differentiate themselves. "Account-specific activities can involve significant cost," notes Shingles. "But most manufacturers don't include this cost in their brand P&L, and the return on this customer-related activity isn't measured."