Your biggest-spending customers aren’t necessarily your most profitable. Customer profitability subtracts the cost of gaining and maintaining a customer from the amount of revenue they generate. It’s a metric that helps you sharpen your marketing efforts, devise retention and loyalty programs, and allocate resources to the customers who matter most to your business’s success. Learn more about customer profitability and some strategies and tips for your business.
What is customer profitability?
Customer profitability is the net profit your company earns from a single customer during a specific period of time. It’s calculated as the difference between the total revenue a customer generates and the total costs associated with acquiring and serving that customer.
Understanding customer profitability is crucial for designing your business strategy and strategic decision making. By focusing on the actions that increase profit, you naturally build a more efficient and resilient business, gaining a significant competitive advantage.
Here’s how a customer profitability analysis can help your business:
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Reveals your high-value customers. A customer profitability analysis reveals which customers spend money with your business the most efficiently.
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Optimizes resource allocation. This analysis helps you use your resources more efficiently. You can justify dedicating your most valuable assets—like your senior sales reps, personalized marketing campaigns, and premium support—to the high-impact customers who drive your profitability, while finding more cost-effective ways to serve the rest of your client base.
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Drives more targeted customer acquisition. Understanding the profile of your high-profit customers can help you adjust your marketing strategies and customer acquisition efforts to attract more clients like them, leading to a more profitable customer base.
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Helps prioritize customer retention efforts. Every business wants to reduce churn, but you can’t apply the same level of effort to every customer. This analysis identifies your most profitable clients, so you can proactively monitor their satisfaction and prioritize their needs to keep them from leaving. This helps you protect your most valuable revenue streams.
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Shows the full cost-to-serve. A profitability analysis must also include the acquisition costs. You might discover your sales team spends significant time and resources to win deals that yield little profit. This insight lets you redirect sales efforts toward more valuable leads.
Factors contributing to customer profitability
The factors that contribute to customer profitability vary by industry. Here are some examples of different business models and how their customers help them earn money:
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Software as a service (SaaS). Profit is determined based on a customer’s subscription tier and how often they use your support resources. A customer on a high-tier plan with low support needs is highly profitable; someone on the cheapest plan that relies heavily on your tech support department is not.
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Retail or ecommerce. Profitability is influenced by average revenue per order, purchase frequency, product return rates, and shipping costs. A customer who buys full-price items frequently and rarely makes returns is ideal.
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Professional services. For businesses that sell expertise and time—like marketing agencies, consultants, IT specialists, or accounting firms—profitability hinges on the balance between billable hours and the costs of managing the client. A high-value client can become unprofitable if their project suffers from scope creep, where they continually request work beyond the original agreement without additional payment.
Manufacturing. Client profitability factors include order volume, product customization requirements (which has the potential to increase labor costs), and supply chain logistics. Large, predictable orders are generally more profitable.
How to measure customer profitability
To calculate customer profitability, you need to compare the revenue a customer brings in with their associated costs.
1. Gather revenue data
To get started, pull data directly from your own business systems. Your accounting software, customer relationship management (CRM) platform, or ecommerce system—like Shopify—lets you track and export revenue on a per-customer basis. Using this data, sum up all the revenue a particular customer has generated within a specific time frame, such as a month, quarter, or year. This total revenue generated can come from product sales, service charges, subscription fees, and any other income source.
2. Total up expenses
Next, identify all the business expenses incurred to win and support each customer. Categorize these costs as direct or indirect as follows:
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Direct costs. These direct expenses are tied to a specific customer, like the cost of goods sold (COGS) for the products they purchased, commissions paid to the sales representative for their account, or labor costs for services rendered.
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Indirect costs. These are operational costs that aren’t tied to a single customer but must be allocated across your entire customer base. Although this includes fixed costs like rent, it also includes the variable use of staff resources. A high-maintenance client might eat up time from your customer support team or have a high rate of product returns that require excessive administrative time.
3. Use the customer profitability formula
If you have your revenue and costs, the customer profitability formula is simple:
Customer profitability = Total customer revenue - (Direct costs + Indirect costs)
For example, a customer generates $10,000 in revenue for a business during a year. The direct costs for their purchases are $4,000, and your analysis found $1,500 in indirect costs.
Here’s the calculation for customer profitability:
$10,000 - ($4,000 + $1,500) = $4,500
Although analyzing every individual customer this way may not be practical for a large business, this process is typically automated by pulling data from your CRM, accounting, and support software. Businesses often group customers into segments by industry, contract size, or acquisition channel to analyze profitability trends. By running this analysis across key segments, you can build a clear picture of which types of customers are truly driving your business forward.
Strategies to improve customer profitability
- Segment your customer base by profitability
- Double down on your high-value customers
- Optimize your pricing strategies
- Develop targeted marketing campaigns
- Manage costs for low-profit customers
Once you’ve identified your profitable customer segments, the next step is to use that information to maximize customer profitability across your business. Here are five strategies to consider:
Segment your customer base by profitability
Rather than demographic customer segmentation, group your customers into profitability tiers. This lets you develop tailored strategies for each:
- High-profit customers. These customers are your VIPs, the ones who earn you money with the fewest hassles.
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Break-even customers. This group has the potential to purchase more but may need nurturing or better cost management.
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Unprofitable customers. Also known as your problem children, unprofitable customers cost you more than they bring in.
Double down on your high-value customers
Your most profitable segment obviously deserves the most attention. Focus on increasing their customer lifetime value (CLV), or the total net profit you can expect to earn from a customer throughout your entire relationship. You can do that by implementing loyalty programs, offering exclusive access to new products, assigning them an account manager, and proactively seeking their feedback. Strengthening these long-term customer relationships will help maximize revenue growth.
Optimize your pricing strategies
A one-size-fits-all pricing model rarely works. Use your profitability data to help with pricing. One option is tiered pricing, where customers who use more resources (such as support) pay more. Explore value-based pricing that ties your price to the financial value your customer receives. Well-designed pricing strategies help increase profit margins.
Develop targeted marketing campaigns
Use your insights to create targeted marketing strategies that attract higher-value customers and get more value from your existing ones. For example, you could launch referral programs targeting your high-value customers because they may know others with similar profiles.
Manage costs for low-profit customers
Start by analyzing your customer behavior. Are they overusing support? Guide them toward any self-service options you may have. Is it possible to automate aspects of their service delivery? Sometimes, simple process improvements can turn unprofitable customers into profitable ones.
Customer profitability FAQ
What is the 80/20 rule for customer profitability?
Also known as the Pareto Principle, the 80/20 rule for customer profitability suggests that roughly 80% of a business’s profits come from 20% of its customers. A customer profitability analysis is the tool that proves or disproves this rule for your specific business.
What is an example of customer profitability?
Let’s compare two different patrons at a local coffee house. The first is a regular who stops in every weekday for a basic $5 coffee. The second brings in their team once a week, spending $40 per visit on complicated orders that overload your staff and keep other customers waiting. At first glance, the second customer may seem more valuable than the first. Then you factor in the extra labor, potential for corrected orders, and the operational slowdown—the low-maintenance regular may prove more profitable.
What factors impact customer profitability?
A customer’s profitability is ultimately a balance of the revenue they generate against the costs required to serve them. Key revenue factors include their purchase volume, the types of products they purchase, and any discounts they receive. On the cost side, expenses for customer acquisition, support services, and order fulfillment directly reduce their net profit and value to your business.
