Key account customers in a business to business market are identified by the selling company as being of strategic importance to them. Key Account Management is an integrated process for managing the relationship with these customers profitably.
The issue of whether a customer is profitable and how to measure their profitability is critically important. Many key account managers are now tasked to manage not just the revenues but also the stream of profits from these customers.
How do you measure profitability of a customer? The degree to which customers are profitable or unprofitable can change substantially from period to period and some customers can be unprofitable at least in the short term.
For our portfolio of key account customers, a more suitable measure than customer profitability is needed. We need to consider the life time value (LTV) of a customer and customer equity, rather than look at short term profitability.
Customer life time value is the forecast value of an individual customer throughout the life time of their relationship with the company (Berger and Nasr 1998, Mulhern 1999). It is therefore of considerable interest to key account managers, whose individual customers are so large that their life time value should be calculated individually. Customer equity is the potential value of the entire customer portfolio calculated as the sum of the entire LTV’s of each customer.
Traditional accounting methods provide little help in calculating profitability at an individual customer level. Each customer is different and that each $1 of revenue or gross margin does not contribute equally to the profits of the business.
Customers use resources differently; therefore the “cost to serve” (CTS) can vary significantly from one customer to another. On their own, revenue and gross margin can be unreliable indicators of profitability.
The Cost to Serve (CTS) a customer results from a combination of characteristics, behaviours and the resultant activities they consume. Characteristics tend to be the fixed and obvious factors such as product range purchased and delivery options. Whereas “behaviour” tends to be more about the way a customer chooses to operate, for example they may wish to only deal with senior management.
The results of a thorough profitability analysis may contain many surprises and we need to segment key account customers based on profitability and then develop strategies for retaining or improving profitability in individual Key Account Plans.