Activity-based management (ABM)
3.1. Example of customer cost analysis
To better understand how customer cost analysis is done, let's look at the following example.
Friends Company, a manufacturer of valves, has the following customer costs and cost rates:
Activity |
Cost Driver |
Cost Rate |
Order taking |
Orders taken |
$25 per order |
Order processing |
Processed orders |
$18 per order |
Order processing |
Processed items |
$1.25 per item |
Delivery |
Number of orders |
$120 per order |
Delivery |
Miles |
$ 1 per mile |
Expedited delivery |
Number of expedited orders |
$600 per order |
Customer visits |
Number of visits |
$160 per visit |
Monthly billing |
First statement |
$6 per statement |
Monthly billing |
Subsequent reminders |
$15 per reminder |
Sales returns |
Number of returns |
$80 per return |
Restocking |
Number of items returned |
$5 per item returned |
Friends Company also incurred the following costs: $120,000 per month in sales personnel salaries and $60,000 per month in office expenses.
The abovementioned costs, as well as the costs in the table above, can be grouped as follows:
Customer Cost Category |
Customer Cost |
Customer unit-level costs |
Order processing (per unit) |
Restocking |
|
Customer batch-level costs |
Order taking |
Order processing (per order) |
|
Delivery (per order) |
|
Delivery (per mile) |
|
Expedited delivery |
|
Sales returns |
|
Customer-sustaining costs |
Sales visits |
Monthly billing (1st statement) |
|
Monthly billing (subsequent reminders) |
|
Sales-sustaining costs |
Sales office salaries |
Sales office expenses |
To perform a customer cost analysis, let's continue the Friends Company's example. Friends Company has the following three customers: AutoCo, Motor, Inc., and Fast Bike LLC. The following data pertains to the aforementioned clients:
AutoCo |
Motor, Inc. |
Fast Bike LLC |
|
Total sales |
$ 100,000 |
$ 360,000 |
$ 450,000 |
Sales discounts |
2,000 |
8,000 |
14,000 |
Sales returns and allowance |
12,000 |
15,000 |
65,000 |
Cost of goods sold |
56,000 |
260,000 |
302,000 |
Number of orders |
7 |
16 |
44 |
Average items per order |
500 |
380 |
150 |
Delivery miles |
20 |
35 |
46 |
Number of expedited orders |
0 |
1 |
6 |
Number of customer visits |
1 |
2 |
4 |
Number of reminders |
0 |
1 |
4 |
Sales returns |
2 |
3 |
12 |
Average units per return |
30 |
34 |
20 |
Let's look in greater detail at the calculation of the total customer cost of Motor, Inc.
Motor, Inc. |
||
Activity |
Cost ($) |
Calculation |
Order taking |
400 |
= $25 per order x 16 orders |
Order processing (per order) |
288 |
= $18 per order x 16 orders |
Order processing (per item) |
7,600 |
= $1.25 per item x 16 orders x 380 items per order |
Delivery (per order) |
1,920 |
= $120 per order x 16 orders |
Delivery (per mile) |
560 |
= $1 per mile x 16 orders x 35 miles |
Expedited delivery |
600 |
= $600 per order x 1 order |
Customer visits |
320 |
= $160 per visit x 2 visits |
Monthly billing (1st statement) |
6 |
= $6 per statement x 1 statement |
Monthly billing (reminder(s)) |
15 |
= $15 per reminder x 1 reminder |
Sales returns |
240 |
= $80 per return x 3 returns |
Restocking |
510 |
= $5 per item x 3 returns x 34 items per return |
Total |
$ 12,459 |
Using the formulas presented in the table above, we can calculate the customer cost of AutoCo and Fast Bike LLC. The customer cost analysis of the Friends Company's three clients is as follows:
AutoCo |
Motor, Inc. |
Fast Bike LLC |
|
Order taking |
$ 175 |
$ 400 |
$ 1,100 |
Order processing (per order) |
126 |
288 |
792 |
Order processing (per item) |
4,375 |
7,600 |
8,250 |
Delivery (per order) |
840 |
1,920 |
5,280 |
Delivery (per mile) |
140 |
560 |
2,024 |
Expedited delivery |
0 |
600 |
3,600 |
Customer visits |
160 |
320 |
640 |
Monthly billing (1st statement) |
6 |
6 |
6 |
Monthly billing (reminder(s)) |
0 |
15 |
60 |
Sales returns |
160 |
240 |
960 |
Restocking |
300 |
510 |
1,200 |
Total |
$ 6,282 |
$ 12,459 |
$ 23,912 |
After we have determined the cost of each customer, now we can perform the customer profitability analysis.