How much of the company’s total costs should not be allocated to customers when analyzing customer profitability?
The correct answer and explanation is:
Correct Answer: Costs that are not traceable to specific customers or customer segments should not be allocated when analyzing customer profitability.
When analyzing customer profitability, only costs that are directly related to serving individual customers or customer segments should be considered. These are called traceable or customer-specific costs. They include costs like sales support, order processing, delivery, and customer service. These costs can vary depending on the behavior and requirements of specific customers.
On the other hand, some costs are considered general or corporate-level costs. These include expenses like executive salaries, building rent, general administrative overhead, or company-wide marketing campaigns. Such costs are incurred regardless of how many customers the company has or which specific customers it serves. They are not influenced by individual customer actions and are difficult to assign meaningfully to specific customers.
Allocating non-traceable costs to customers can distort the analysis and lead to incorrect decisions. For example, a company might believe a customer is unprofitable simply because it has been assigned a share of general administrative costs that do not reflect the actual cost of serving that customer. This could result in ending valuable customer relationships or setting incorrect pricing strategies.
Instead, customer profitability analysis should focus on revenues generated from each customer minus the direct costs to serve that customer. This helps management understand which customers are truly contributing to the bottom line and which may be consuming more resources than they return in profit.
In summary, when evaluating customer profitability, only costs that are directly related to serving those customers should be included. General overhead or corporate-level costs should be excluded from this analysis to provide an accurate and useful assessment.