Relevant Information and Customer Profitability

What information is relevant in cost-related decision making?

It must occur in the future and differ among alternatives

What are the different types of relevant information?

Qualitative and Quantitative

Qualitative

measured in numerical terms

Quantitative

difficult to measure in numerical terms

What is tricky about relevant information?

Not all variable costs are relevant, and not all fixed costs are irrelevant. It is easy to assume that.

Some variable costs don’t change between options (making it irrelevant) and some fixed costs do change in the long-term (making it relevant)

What are the different types of relevant cost analyses?

Prescriptive Analysis

Predictive Analysis

Descriptive Analysis

Diagnostic Analysis

When to use relevant cost analysis

Constrained Resources (capacity analysis)

Changing Conditions (what if analysis)

Descriptive Analysis

answers: what happened?

Uses past data to describe what happened or what is happening

Diagnostic Analysis

answers: why it happened

“it” is what was found in descriptive analytics

Predictive Analysis

Predicts future outcomes based on past data

Prescriptive Analysis

Provides recommendations based on the other types of analytic results

Customer profitability

How each individual customer contributes to the overall profit

Why shouldn’t we assume that every customer is profitable because the organization as a whole is profitable?

It can lead to poor decision-making and the potential subsidization of nonprofitable customers

How to assess customer profitability

Do a customer profitability analysis; determine whether the gross profit from a sale to an individual customer exceeds the customer-specific costs of serving that customer

Types of customer profitability analyses:

Customer profitability profile

Customer profitability ratio

Customer profitability ratio

Customer profitability / Total Organization Sales

What can be done with nonprofitable customers?

Drop the nonprofitable customer (Note: will not reduce total fixed costs)

Lower the support costs of the low-profitability customers

Why should we keep a nonprofitable customer?

Elimination of nonprofitable customers does not immediately translate into increased overall profits

Relevant information for deciding to drop a customer…

are their customer-specific revenues/costs

When a customer is dropped, certain shared costs, unavoidable fixed costs, will have to be ________ by retained customers

absorbed