Reference no: EM13875742

Return on Customer; Review The concept of return on investment (ROI) has been adapted widely for a variety of uses. One recent development is to extend customer profitability analysis to include the concept of "return on customer." We presented an approach for using ABC to determine the full cost of serving a customer, including product and service, thereby determining the net profit from serving that customer. The analysis was further extended in Chap- ter 5 to calculate a measure of the expected value of the customer based on expected future sales. That value was called customer lifetime value (CLV), which is the net present value of all estimated future profits from the customer. For example, assume a customer is expected to produce profits of $20,000 per year for each of the next three years. Using a discount rate of 6 percent, the CLV for this customer is 2.673 X $20,000 = $53,460.

Return on customer (ROC) can be measured as the increase in customer value plus the current year profit on the customer, relative to the prior year value of the customer. The first step in calculat- ing ROC is to determine the customer lifetime value (CLV) at the end of each year. CLV can rise or fall, as our projections of future profits from the customer increase or decrease. Suppose we have the following information for customer Y:

Customer Lifetime Value at the end of 2009 = $2,000,000 Customer Lifetime Value at the end of 2010 = $2,500,000 Profit on sales to customer Y during 2010 = $250,000

ROC for customer Y for 2010 is determined as follows:

ROC = Profit from customer Y in 2010 + Change inCLV from 2009 to 2010
CLV for customer Y in 2009
ROC for customer Y = $250, 000 + ($2, 500,, 000 $2, 000, 000) $2,000,000 = 37.5%

ROC gives management a way to further analyze the profitability of a given customer. The goal is to attract and retain high-ROC customers.

Required: Assume Customer X has a CLV at the beginning of the year of $150,000, a CLV at the end of the year of $75,000, and that profits from sales to X were $25,000 during the year. Customer Z has a CLV at the end of the year of $100,000, a CLV at the beginning of the year of $50,000, and profits from sales this year of $10,000. Determine the ROC for each customer and interpret the results for these two customers.