The document discusses how understanding true customer profitability, which equals revenue minus all visible and hidden costs, is vital for businesses using big data. While big data can provide detailed customer information and predictions, it often overlooks hidden costs, keeping true profitability hidden. An activity-based costing analysis that links customer interactions to internal business processes can reveal which customers are profitable by accounting for all costs involved. Combining big data with an understanding of cost drivers allows businesses to optimize profits by cementing high-value customer relationships, avoiding unprofitable customers, and setting appropriate prices.

1. Accurate Net margins –
The Missing Dimension of Big Data
Customer profitability equals Revenue less the visible & hidden costs of the relationship.
The visible costs are easy to find, they are on the ledger. But the real customer profitability can stay hidden deep in the business. So
understanding all the costs that customers drive is vital to knowing which customers are profitable or not - and why. An Activity Based
Costing analysis completes that understanding.
Technology rushes on. Now you can record and process all
available facts about your customers. You can log their every
purchase and preference. You can store details of each transaction
and interaction, be it through call centre, e-mail or post. If
customers visit your web site, you know their every key stroke and
click. If you get it right, you can predict customers' every need and
anticipate their every whim.
Just as good salespeople, but at a fraction of the cost, you can
package and price offers not to target a niche, but an individual.
Buying decisions become quicker and easier because customers
are propositioned only with what they find attractive, in a process
they judge convenient, safe and painless. And on top of all this,
sales costs plummet as the need for expensive salespeople and
high street outlets, and for low turning showroom stock,
disappears.
So where's the catch?
In fact there are two. The first is that all your competitors will be
doing the same thing. So unless the business can take an early
lead and then defend the additional market share, or unless the
concoction of technology and marketing that Big Data feeds
increases the size of the total market, your only hope is to do it
better than competitors. This is the relentless pursuit that
businesses are trying to do every day.
The second catch is that all the hyperbole about Big Data usually
has a different message to the customer. It says lower prices. So
instead of being able to pass on to the customer the cost of all the
expensive technical wizardry, you find that margins are squeezed
even more!
So is Big Data merely a development in which you are forced to
participate as a defensive measure, to the benefit only of
customers and to ward off competitors? Not necessarily.
Big Data is aimed at capturing information that will allow you to
create and improve the circumstances in which customers will buy.
It maximises the attractiveness of the offer and the convenience of
the sale by matching the products and the selling process to the
right customers. But in making the match it risks driving hidden
costs into the business, be it by shortening delivery lead times, by
encouraging complex product variants, by offering high levels of
personal service, or by attracting customers whose behaviours
trigger excessive and largely hidden costs.
Big Data helps anticipate every interaction the customer might
have with the business, before, during and after the sale. All well
and good but the key missing dimension is knowledge of costs
and therefore true profitability.
Identifying customer revenue is easy: it's called the sales ledger;
but when the dust has settled on the new Big Data
implementation the real customer profitability stays hidden deep
in the business. So understanding all the costs in the business
right down to supplying and servicing each and every customer is
vital to setting the rules around ‘good and ‘bad’ customers and the
levels of service and prices that you offer.
A clear understanding of customer profitability allows your
business to differentiate the level of service it provides to various
customer segments according to their needs and their value to the
company. For example, you may offer higher service levels to
prized customers in the form of dedicated telephone lines, more
individual attention, incentive pricing or customised products. At
the same time, you might choose to reduce service to unprofitable
customers or increase prices. Even let unprofitable customers drift
to competitors who, if they are measuring only sales and gross
margin, will never know that you have burdened them with
additional losses.
A comprehensive view of the costs that customers drive allows a
business to refine its alignment of resources where they will have
the greatest effect on profits: cementing relationships with the
right customers; avoiding excessive costs; matching prices to the
service given. In many sectors the customer continues to provide
revenue and to drive costs well after the initial sale, through after-
sale service, repeat purchasing or general administration. All
these costs, as well as the revenues, need to be identified and
analysed if you are to ensure that the initial terms are profitable
and that the customer segments you target have a high probability
of being profitable over the lifetime of the relationship.
The fundamental task is two-fold. Firstly, the unit costs of
activities in the business need to be identified and related to
internal processes. Secondly, customer interactions need to be
captured from all the various systems in the company in which
they reside. Linking these two sets of data enables a picture of
customer profitability to emerge. It is a picture, once drawn that
can be viewed either at the level of individual customer or at
whatever level of customer segmentation you define.

2. A typical ‘Activity Based Costing’ analysis for a Utility is shown in
the diagram below. It reveals that a customer doesn't have to be
a rogue to be unprofitable – too many interactions with the
business soon wipes out profits.
And when an analysis of the real profitability of every customer is
undertaken a universal law of business is always revealed - not all
customers are created equal in the sight of the supplier.
They behave differently from one another and have a variety of
characteristics, so they generate different costs and net margins.
Some are highly profitable, others are spectacularly unprofitable,
and many lie in-between.
Another typical analysis from a Utility is shown in the diagram
below.
This curve captures the attributes of customers concerning
behaviours that drive costs into the business. If we add to this data
the attributes that Big Data captures about customers then we can
get beyond revenue and gross margin and predict the real
profitability (net margins) of customers based on a host of
attributes.
The marriage of cost information and marketing data is one made
in heaven. But although they make a perfect couple, surprisingly it
is only recently that the right combination of analytical tools have
become available that work together with ease.
Uncovering, simulating and predicting net margins provide the
knowledge that will be the source of significant competitive
differentiation.
And if this wasn’t enough, an added benefit of the customer
profitability analysis is that it highlights the costs of poorly
designed internal processes. As the true costs of processes
emerge, managers can sense which costs are suspiciously high.
This triggers a cycle of further investigation, problem identification
and process improvement, thereby correcting profit-harming
defects that would otherwise continue undetected.
Big Data undoubtedly leads to opportunities for revenue
enhancement, but as net margins have little correlation with
revenue or gross margins, wrong interpretation of Big Data could
risk cost escalation. For businesses with tight margins,
understanding and controlling costs can have as much or more
influence on profits as can increased revenues.
Combining Big Data with a clear understanding of how costs are
driven in the business provides the winning formula. Once you
determine true net margins then you have found the missing
dimension of Big Data.
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Brian Plowman is Managing
Director of CostPerform Ltd
the UKI marketing, sales and
implementation support
channel for the Activity Based
Costing, Analysis and
Modelling software tool
CostPerform.