What is the True Cost of a Customer?

February 9, 2017 Scott Simpson

Most dealers precisely know their gross margins on a per-customer basis. If you’re a typical LBM business, you work on about a 25% gross profit margin.  Of those 25 points, 20 are usually consumed by overhead, leaving you with a 5% net margin. Some dealers are higher, some lower.

Very few dealers know their net margin on a per customer basis. If you think about what goes into overhead, they are things like delivery expense, sales and marketing, cost of bank borrowing, legal and lien expense, etc. Are these expenses consumed by your customers in direct proportion to their sales volume? I’ll save you the suspense – they’re not. As a result, if you took the effort to allocate those expenses by what each customer actually consumes, you’d find your true net profitability for each customer. What you will realize is that not all customers contribute equally to the bottom line.

To highlight this point and show where perceptions can be wrong, let’s take an example. Ask yourself: Are large customers more profitable than smaller ones? 

It’s possible. It also might prove the opposite. Your big customers typically get the best pricing for their large volumes, which means a lower-than-average gross margin to start. Instead of making 25% gross margin, you may be making 19%, before your overhead is paid down.

And the margins for large customers can get even thinner: Big customers often get the attention of your top salesman, they get specialized delivery, and favorable return/restock terms.  When a dispute pops up, you are quick to accept responsibility and accommodate without delay.  After all, they’re a big customer, right?

Now look at the big customer from the perspective of A/R. Perhaps these customers are also the ones that insist on paying you 60 days late, and politely letting your A/R person know that they won’t pay late fees.

Add all that up, and you may not be making 5% net margins, but shocked to find you are not making any money at all! Trust me, that’s more common than you might expect.

To calculate per customer profitability, attempt to allocate the share of overhead expenses each customer is actually driving. Look especially in the following areas…

Interested in reading the full article?  Check out: What is the True Cost of a Customer?

About the Author

Scott Simpson

Scott is president and CEO of BlueTarp. He has spent the majority of his twenty year career in financial services helping businesses grow more rapidly through the effective use of credit.

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