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8/25/2004
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Customer Profitability Is Not A Financial Metric

Try treating customer profitability as a demand chain metric, not a financial measure.

VentanaView

Summary

Demand chain performance improvement initiatives with a customer-centric focus take on additional color when built upon a customer profitability foundation. And yet there remain barriers to the rigorous application of customer profitability at many organizations. Ventana Research recommends that treating customer profitability as a demand chain metric, not a financial measure, is one path to overcoming many of those barriers. Barriers to reaching cultural and functional consensus have a different texture with a demand chain mind-set, and the proper application of enabling technologies can still provide the foundation for the more precise requirements of CFOs. Ventana Research advises organizations to take an incremental approach, refusing to accept imprecision as an excuse for inaction.

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Performance improvement strategies built on customer profitability measurement make so much sense that it is remarkable that they are not the norm. One barrier to adoption is that initiatives must begin with business metrics that matter. In most organizations, relevant data exist, though not often in the form or format needed, and clearing the hurdles that lie in the path to understanding customer profitability often requires that the organization accept a degree of imprecision in its measurement. Solutions often involve estimation and judgmental allocation, which is anathema to many CFOs, particularly in today's business climate. Ventana Research therefore recommends that companies initially attack the tough issues outlined here as non-financial demand chain problems in order to combat organizational inertia.

Defining "customer." The challenge of simply defining the customer dimension confounds many organizations. Functional perspectives on the customer differ in demand chain, finance and elsewhere, often with justifiable logic. Within silo-ed applications, an appropriate definition of "customer" in functional context is often self-evident. It's easy to rationalize sub-optimal solutions in deference to project deadlines and other pressures. The result can be inconsistency across applications, even within a business area.

It is our belief that companies must reconcile these inconsistencies and address them with a little work by a committed organization. A small group of business and IT representatives can be chartered to conduct a requirements gap analysis and outline a small number (three is a good choice) of options aimed at short-term resolution consistent with best practices and organizational objectives. These options can then be brought to a cross-functional decision-making body for final arbitration.

Customer data integration. This endeavor has been known to occupy entire careers. Issues abound with respect to physical and logical integration. Much has been written about both, and a number of vendors offer solutions. The point in highlighting the topic here is simply to suggest that an elusive ideal business solution should not prevent pursuit of what is immediately doable. If nowhere else, customer data is almost always retrievable in some form from sales and order processing systems — a "bill-to" designation for instance. This can provide a jumping-off point for debate if other options don't present themselves; a catalyst for evaluation of other systems and viewpoints.

Value metrics. With some customer dimension as a reference point, relevant metric definitions on that dimension can be pursued. Two metrics commonly applied are customer lifetime value and customer profitability. Lifetime value as a concept comes from marketing, especially direct marketing circles. Customer profitability has financial roots. The latter is arguably an extension of the first, accounting for costs as well as revenue.

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