Profitability and Difficult Customers
If you have difficult customers or clients that routinely give your business a hard time, do you quantify the cost of continuing this relationship and include this in a measure of customer profitability? If you do not, you should.
Rework Costs and Customer Profitability – Service Business Example
Here’s a simple example related to re-work costs. I’ll use a service provider as the business. Businesses get complaints, but some customers or clients have elevated these situations to an art form.
If it costs this service provider $50 in materials and labor to complete one job and every re-work costs $20/job on average (40% of the cost to complete the job the first time through), then every re-work job costs this business $20 in gross profit.
Let’s also assume this service provider nets $50 in gross profit for every completed job the first time through.
But the $20 loss in gross profit is not the entire picture. That $20 in lost materials and labor doing re-work is also an opportunity cost to this service provider.
If this customer buys 100 jobs (a month) but demands re-work (to their satisfaction) on 20% of these 100 jobs, then this customer’s gross profit amount is cut by $800 every month. This means that $5,000 in monthly gross profit is reduced to $4,200.
That’s $800 less to cover overhead and indirect costs or $9,600 on an annualized basis considering that only 20% of all jobs are re-worked.
The economic impact to this service provider is not just the cost of the re-work but the additional cost of diverting resources away from (new) profitable jobs toward re-work jobs that contribute no additional revenue.
Stated in a different way, If the activity and materials consumed gets this provider 40% toward completing a new job, then the benefit that is forgone is 40% of the gross profit of $50 or $20.
Impact of Order Changes to Manufacturer’s – Big Problems
This same scenario also applies to changes for product orders that have already been placed.
This is particularly problematic for manufacturers to manage.
If a customer changes an order to a manufacturer, then the manufacturer has to determine if any of the work-in-process can be re-worked and used.
This is going to depend on how close the original order was to completion, the scope of the change(s) requested by the customer and the availability of resources needed to complete the change(s).
This is further complicated by the fact that most modern manufacturing processes cross-load and share resources across several products and product lines. This means that many products can be impacted by delays due to re-work changes on a single part.
So, you quote re-work costs to this customer, what’s the big deal you ask?
Does the cost of the re-work consider all the opportunity costs for more profitable jobs that are either delayed or worse, forgone?
Large customers based on sales volume can exercise a lot of control over a manufacturer. But if these same customers routinely change their orders, do you know the impact of these changes to the overall profitability of this customer? If the customer is NOT profitable, and a significant amount of your internal resources are tied up in re-work and expediting changes, you’re forgoing the ability to bid and secure jobs with more profitable customers.
The Value of Having an Accountant and Tax Pro with Broad Expertise
Accounting and Tax work is more than compliance and filing forms. Your Accountant and Tax Professional should be helping you determine which customers to keep and grow and which ones to de-emphasize and lose.
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