This second in a two-part series highlights some of the impacts arising from customer accounting and the decisions associated with the provision of “more insightful” information.
In recognising the value of a customer base over a longer period of time, more informed decisions can be made. Many of these decisions will involve capital expansion to further improve customer profitability and firm value.
Part one explored strategic management accounting and profiled customer accounting. This article provides an overview of Strategic Investment Appraisal and Operational Investment Appraisal, and concludes with a customer profitability checklist for use when current investment is not considered an appropriate option and divestment is being considered.
Strategy meets growth: investment appraisal
Accurate customer accounting provides the basis to understand and accurately attribute revenues and costs to customer groups or individual customers.
Such a basis facilitates more informed decision-making for customer related strategy, pricing and also investment, according to Ken Bates, business adviser and lecturer at Victoria University of Wellington.
On this latter point, Bates distinguishes between operational investment decision-making and strategic investment decision-making.
The former encompasses “everyday” investment decisions where risks and outcomes are readily understood. Examples of operational investments may include the replacement or expansion of existing assets, or investment in products and markets similar to the current operations.
In contrast, strategic investments may change the course of the entity’s current mode of operation. Examples of this may include mergers or acquisitions, expansion into a new line of business, and substantial shifts in capabilities. Bates adds that such decisions may be characterised by significant long-term financial commitments and have high levels of uncertainty.
Strategic investment analysis attempts to capture often-neglected strategic reasons for a project to proceed by integrating financial and strategic considerations into the investment appraisal process.
As a general rule, strategic investment analysis techniques require greater input from the organisation’s senior management team as such analysis should not be left to the “financial experts” alone.
Bates details five such tools below and notes that some, such as Technology Roadmapping, are still in their infancy and not covered in any given instructional textbook – although future coverage is intended.
- Real Options Analysis (ROA) – is also referred to as real options valuation and is the right (but not necessarily the obligation) to undertake or refrain from undertaking a particular business initiative. For example, a public practitioner may wish to invest in an expansion activity or alternatively sell the current practice.
- Fuzzy Set Theory (FST) – applies where no clear binary outcome appears to make sense. Such an application is best used when data is considered unreliable, measures are imprecise and decision rules are unclear. Such decision making has been used when considering whether opening or shutting a mine operation constitutes a good idea. The heavy use of mathematical modelling makes this option unrealistic for most New Zealand organisations.
- The Balanced Scorecard – was profiled in February’s Journal. A key characteristic of the balanced scorecard is the systems perspective, adopted with performance management, that includes forward-looking, non-financial measures to supplement historic financial information. The coupling of non-financial and financial data in a manner that links short-term action to the organisation’s strategic plan reduces the reliance on short-term financial measures as the sole indicators of performance.
- Strategic Cost Management – aims to improve the strategic position of the organisation and reduce cost. An example of strategic cost management was given in part one of this series where improved quality decreased the net cost and savings where channelled into frontline resource. Furthermore, techniques frameworks such as activity-based cost management may also be considered to form and integral part of the strategic cost management approach.
- Technology Roadmapping – is the mapping of new products and processes to the technology that is required to enable them. The increased cost of providing technology is significant and important for many organisations. To avoid unplanned capital expansion that frequently cannot be delayed without underpinning the strategic position of the organisation, it is imperative that such mapping takes place.
Bates notes that only some of the five strategic investment appraisal tools have made their way into mainstream organisational practice.
Strategic cost management and the balanced scorecard are two of the most recognised in this regard. However, the remaining three, while used in various industries and practices around the world, have little application in a New Zealand accounting context.
Bates surmises that one of the main inhibitors to their more widespread use is their reliance on advanced probability mathematics.
While economic indicators remain downbeat and austerity measures are in sharp focus it is unlikely that management accountants will have an immediate and heavy reliance on strategic investment appraisal tools. However, it is important to recognise that recession is merely one part of an economic cycle, and professional accountants need to pre-empt the business context and produce the most forward-looking and insightful information possible.
The need to pre-empt growth and use tools that enable insightful information in this context is therefore a key emerging theme. However, in the meantime the management of unprofitable customers may be a more immediate reality.
So far this article has explored the tools that might be considered useful should further capital investment be warranted. However, the potential benefit of divestment should be seriously considered, for example when customer accounting measures show that some customers may not be profitable now or in the future.
A degree of caution must be exercised for several reasons. The first concerns reputational issues. The second is that customer profitability measures do not generally reflect the contribution customers make to fixed costs, thus the firm’s capacity position and its ability to avoid “fixed” costs must be considered. Third, different customers have different risk profiles, hence increased profit may also be combined with increased risk, a familiar idea to those involved in assurance type work.
Against the backdrop of such cautions the customer profitability checklist that follows goes some way to establishing a process for managing unprofitable customers.
Customer profitability checklist
In 2009 a six-step framework for managing unprofitable customers was designed by Haenlein and Kaplan. Managing customers forms an essential element of customer accounting and is summarised in the six “ABC steps”.
- Step #1: Avoid their acquisition in the first place – entities need to have adequate screening processes in place. This includes remuneration structures and incentives for sales staff, underpinned with appropriate information systems to provide necessary support and accountability. While simultaneously avoiding unprofitable customers, attention should also focus on retaining the most profitable.
- Step #2: Bear in mind potential rescue operations – while it is simply not possible to ascertain the future value of a customer with certainty, the cost of acquiring one is frequently known. Customer acquisition is normally more expensive than customer retention. Thus, it often makes more sense to retain a customer and re-examine ways of ensuring that a profitable situation arises. Unprofitable customers are sometimes “misunderstood” in terms of the way products and services are matched to their requirements.
- Step #3: Catch the possibility of abandonment – Price increases and “partial service withdrawal” are viewed as the most common ways to ensure that only profitable customers remain within an entity’s portfolio. In some situations it does not make commercial sense to retain some customers.
- Step #4: Draw up a cost-benefit analysis – before implementing any customer “abandonment” strategy, it is important to understand the associated costs in both financial and non-financial terms. While a negative market place perception from “abandoned” customers may be difficult to measure, it should still be considered. Such consideration may be given greater weighting when the influence of social media is acknowledged as high.
- Step #5: Ensure familiarity with your environment – understanding the competitive and legal environment is essential in deciding the composition of your targeted customer base. A critical mass of unprofitable customers may significantly influence your market share and competitive position in future periods. For example, low-cost airlines may start out by taking unprofitable customers. However, the low-cost providers may later gain what has previously been considered the domain of the mainstream airline market share.
- Step #6: Facilitate biting the bullet – if after reviewing the above steps, an entity still comes to the decision to “abandon” a customer, a thoughtful process must be implemented. This includes being clear about the reason (eg, poor credit history) and reflecting on the future consequences. There are many ways to end any given relationship – some have longer and more positive consequences than others.