While speaking at a recent strategic marketing conference for bankers, I took the opportunity to ask the attendees how many had credible retail customer profitability information at their institutions. In a crowd of almost 200, only five hands were raised.
I then asked how many understood delivery channel cost and had credible transaction unit cost by channel. Only three raised their hands.
Why is credible customer profitability information so elusive when it's rated as one of the top information needs of business managers? Our research at Profit Management Group identified three primary obstacles.
Confusing system functionality. A number of bankers confuse the functions of customer profitability systems with those of other relationship management systems.
Relationship management systems have three major system components: data warehouse systems, data access and delivery systems, and customer profitability systems.
Many of the bankers we have spoken with initially expected customer profitability to be computed by the data warehouse or the data access and delivery systems. Though some of these systems contain expense allocation functions or "rate-times-volume" functions that allow a unit cost to be multiplied by a volume, they typically are not robust enough to credibly account for net income.
The data warehouse system stores information and usually features edit functions to "scrub" incoming data; customer information file functions to link accounts to customers; data mining functions to search the data; and data retrieval functions to retrieve requested data.
Data access and delivery systems present information on the desktop. They contain point-and-click graphical user interface functions to allow users to display required information on screen.
Customer profitability systems perform the myriad calculations required to compute net income by customer. These systems track customer behaviors and compute how much of the bank's resources are consumed by customers as they purchase and use products through the various channels the bank has provided.
Best-practice banks have identified the need for all three types of systems. They create requirements and select three software systems-one for each of these three critical areas.
Antiquated accounting. Most banks still suffer with the outdated methodology known as expense allocation.
Many of the business managers we talk with are dissatisfied with their organizational and product profitability calculations because of the way they are linked to expense allocations. When trying to calculate customer profitability, their dissatisfaction level will rise exponentially.
There are two very important components to measuring and managing the bank, and both should be evident in the accounting. The first is measuring how much resource was positioned to service customers and to process their transactions. The second is measuring how much of that resource was actually consumed by customers.
Using expense allocation, 100% of channel expense is allocated, no matter how much of the channel customers have used. This can distort the costs associated with a particular delivery channel. For example, if a bank successfully diverts a large percentage of its customers from a very costly channel to a less costly one, 100% of the costly channel might still be allocated to the profit-and-loss statement.
Allocating to current revenues 100% of the expense of positioning channel resources misstates customer profitability and leads to poor decision making.
Using expense allocations is like a supermarket determining profitability by subtracting from the day's receipts the cost of all the goods on the shelves.
Shortcuts. Some banks embark on customer profitability projects with an eye toward quickly acquiring information to support decisions about customer retention, target marketing, and channel deployment strategies. In doing so they may create erroneous information that leads to bad decisions.
Some are creating "balance-driven" P&Ls, which use a fixed per-account cost for each of the various types of accounts a customer might purchase. Since each regular checking customer, for example, gets the same unit cost, the only differentiating factor is the average balance. Higher-balance customers thus automatically seem more profitable; channel usage or transaction intensity are not considered.
Another costly shortcut is to substitute another bank's unit costs or industry averages for real cost accounting figures. Though substituting may be expedient, it doesn't provide credible information on how your customers consume the resources your bank has positioned to provide them.
Customer profitability information is too important to guess at. The decisions arising from this information affect the very core of your business.
The solution. A number of banks are addressing the issue of customer profitability thoughtfully. They are conducting projects to identify profitability information requirements and to select software to meet those requirements.
Customer profitability measurements identified as best practice use activity-based costing to account for resource consumption. Activity-based costing, when extended to actual transaction volumes, computes the amount of resource consumed and identifies transactions according to the product and channel used.
This lets managers understand the underlying reasons for profit and loss, as well as how changes in behavior affect profitability.
