A few weeks ago, I was exchanging ideas with a fellow consultant about the importance of customer analysis. We often see dashboards displaying customer revenue data, highlighting the top 10 clients who generate the most income for a company, nevertheless this isn’t a good approach.
Who generates the most profit ?
At first glance, this analysis might seem insightful. However, it overlooks a critical factor: the client who generates the most revenue isn’t always the one who contributes the most to profit.
During a brief consulting session, I spoke with a business owner in the wholesale and retail sector. He mentioned one of his star clients: “This is the client who buys the most from me, and I want to take care of them.” Still, I suggested we examine his customers from three different perspectives:
- Revenue Perspective: How much each client contributes in terms of total sales and business revenue.
- Gross Margin Perspective: How much each client contributes to gross profit.
- Operating Margin Perspective: How much each client contributes to operating profit.
The first two perspectives are relatively straightforward to determine. We know how much each client purchases and the cost of goods sold (COGS), allowing us to estimate gross margin per client.
How to analyze operating margin ?
The challenge arises when analyzing the operating margin perspective. This perspective encourages businesses to determine the operational cost structure of a client, which can be broken down into:
- Cost to Serve: The expense of handling a client’s purchases, which varies based on products and client-specific requirements.
- Relationship or Retention Cost: The cost of efforts to maintain and retain the client.
- Marketing Cost: The investment in promoting new products, attracting new clients, etc.
- Other Product Costs: Any additional costs associated with the product not included in COGS.
Calculating these costs requires applying a costing methodology (a topic for another article). The interesting part is that when we incorporate these variables into customer analysis, our perception of clients changes.
Let’s examine what happens to the clients in the Top 10 by revenue:
The chart above (from left to right) shows the behaviour of the top 10 revenue-generating clients. The vertical bars indicate each client’s ranking across the three perspectives. For example, take the client “San Agustín”:
- In the revenue perspective, they rank as the 7th highest contributor.
- In the gross margin perspective, they drop to 16th place.
- In the operating margin perspective, they plummet to 1,067th place.
In other words, despite being a high-revenue client, their contribution to the company’s profitability is minimal.
The right approach
Now, let’s look at the top 10 clients by operating margin and see where they ranked in the other perspectives.
This case reveals that the client “Nissen Malka”:
- Ranked 57th in revenue.
- Rose to 19th in gross margin.
- Jumped to 5th in operating margin.
This is a surprising insight because it uncovers hidden high-value clients—those who may not drive the most revenue but are the most profitable for the business.
Conclusion
Analysing customers solely from a revenue perspective creates a profitability bias, as it may focus attention on clients who contribute little to actual profit. Instead, businesses should evaluate how much each client contributes to bottom-line profitability—because at the end of the day, what every company seeks is to be profitable.
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Author
Written by our collaborator A. Huertas, based in the Americas, who is an expert in Profitability Management and has more than 20 years of experience implementing cost methodologies to deliver REAL Profit Metrics.
