Customer profitability analysis

Presented by-
Manisha Chourasia
Rashi Agarwal
 Objectives
• To identify the bank which treats its complaining customers best

• To measure market performance of banks regarding satisfaction and

perceived quality among complaining customers

• To identify customer-driven areas for potential improvement to add

value to overall service offering

• To establish and analyze customers’ attitudes towards the banks and

establish the strength of relationship with the individual banks among
customers with regards to the complaints process, complaints
outcome and complaints personnel treatment

• To track performance changes against baseline metrics, established in

2001
 Meaning
• Analysis that assigns revenues and costs to major
customers or groups of customers rather than to
organizational units, products, or other objects. The
results may direct organizational resources toward more
profitable uses. It is an application of segmented
reporting in which a customer group is treated as a
segment. It is especially helpful when combined with an
activity-based costing approach that determines which
activities are performed for each group and assigns costs
based on appropriate drivers. For example, activities,
their drivers, and their costs may be classified as order
level, customer level, channel level, market level, or
enterprise level.
 History of CPA
• The banks currently uses a mixture of first
generation (Bellis-Jones 1989) as well as
Second-generation (Lifetime) customer
profitability analysis (Foster and Gupta
1994)
• Customer relationship profitability is the
difference between relationship revenues
and relationship costs, both adjusted for risk
(Storbacka 1993, Rose 1991, Hartfeil 1996,
Foster et al 1996).
 Banks cost
• The cost of the funds
• provision for losses
• overhead
• deposit insurance
• customer’s usage of bank services.
 Expense components
• Noncredit services
• Credit Services
• Cost of funds
• Loan administration
• Default risk expense
 Revenue components
• Banks generate three types of revenue
from customer accounts:
1. investment income from the customer’s
deposit balance held at the bank
2. fee income from services
3. interest income on loans
 Activity based costing
• Activity-based costing (ABC), a method of determining very accurate
operational and transactional costs based upon the activities associated
with a particular banking process, is a great asset in helping drive
customer profitability. But while driving customer profitability from
ABC is desirable, it is not absolutely essential. Because the bank did
not use ABC per se (legacy systems prevented us from capturing the
necessary transactional data), it used a pseudo customer profitability
value to calculate the true costs of serving customers and customer
segments based on assumptions and average costs or revenues. No
organization has perfect data. But banks need to understand if any
issues with its data are consistent. If they are, then the bank can set
targets, manage performance, and drive customer profitability from
this imperfect data. By understanding the starting point, even if it is not
an accurate one, the bank can be successful
 Customer profitability
The customer profitability for banks now means the profitability at the account
level. One customer can have multiple accounts with a bank. For example, a
savings account, a car loan account, a housing loan account, a locker etc. The
profitability can be calculated for each of these accounts. When we say
customer profitability, it is the Customer P&L for the period. Then it can be
rolled up for a customer. So a customer may not be profitable for a particular
product but may give more profit from the other. Bank can use this
information (if it has got integration of information done) to cross sell, up-sell
or provide some discounts. The customer level information can also be rolled
up to a ‘household’. This helps the bank to propose various products to the
members of the family at their life-stage. This also helps not to propose same
product to different members of the family. For example, proposing same
housing loan to the same family may be a waste of resources. Customer
profitability report can be provided by each product. This information can be
analyzed and utilized by the bank for various purposes.
 Customer Costs

Customer costs are calculated the same

way as activity costs are calculated. Each
activity that is mapped to a customer
brings along an associated activity cost.
The accumulation of those activity costs
determines the customer cost. As with
resource costs, the activity cost mapped
to a customer is based upon the value of
that driver as a percentage of the total
drivers
• Acquisition and maintenance costs are allocated on unit
basis over the life of the customer;
• Administrative costs are allocated on a short-term basis;
• Overhead costs are not allocated over the life of the
customer
• Allocate costs on product basis and indirect cost is
averaged and allocated on the customers. For example,
automatic teller machines’ transaction costs, which can be
directly traced to a customer by analysing that customer’s
transactions.
• Direct expenses for distribution, marketing and
commission are allocated to branches, advertising and
according to purchases respectively
 Target profit
• The target profit is then based on a
minimum required return to shareholders
per account.

• Target profit= (equity/assets)(total return to

share holders)(loan amount)
 Methodology
• Determined the profitability of each account
each month, each customer’s total
profitability has to be computed by adding
together the profits or losses from each of
his accounts.
• Determine the per customer per account
cost associated.
• Deduct the cost from the revenue and the
profit will be arrived
• LCPAM may be analyzed as follows:
• Identification of lifetime revenues and costs of a customer;
• Customer who are unprofitable under first generation (
Short-term ) may be profitable over the lifetime relationship;
• Higher costs shall occur at the beginning of the relationship
and higher revenues shall accumulate as the relationship
develops;
• Lifetime analysis differentiates costs into cost pools to
which relevant cost drivers are attached and costs can be
allocated into following costs pools, such as customer
specific costs, general customer costs, and general corporate
costs
• In banking profit drivers include deposit balance, consistent
fee income, efficient lending practices, relationship building
customers, aggressive retention of profitable relationships,
and quality sales and service .Customer profitability must be
measured over some time period.
 Determining Customer
Profitability
Customer Revenue
• Revenue is generally the most straightforward category to
determine. Companies usually have information that captures
sales/revenue associated with specific customers.
• Other information needed may include customer discounts,
rebates and other deductions.
• In the banking sector customer revenue is generated through
product margins and fees
• Risk
• higher risk products like unsecured credit should be the primary
focus of customer profitability analysis, because the higher risk
products expose the greatest customer variations.
 Calculation of investment income from
demand deposit balances
• Analysis of Demand Deposits:
Corporation's Outstanding Balances for November
• Average ledger balances = ` 335,000
• Average float = ` 92,500
• Collected balance `335,000 - `92,500 = ` 242,500
• Required reserves (0.10) ` 242,500 = `24,250
• Investable balance ` 218,250
• Earnings Credit Rate:
• Average 90-day CD rate for November = 4.21%
• Investment Income from Balances: November
• Investment Income
= 0.0421 (30/365) (` 218,250) = ` 755.20
 Customer profitability analysis for
Banking industries
Banking Industries Banking Industries
Banken Industries
Customer Profitability Analysis CustomerProfitability
Profitability Analysis
Customer Analysis
Loan agreement Loan and Deposit Activity:
Line of credit 5,000,000 Loan and Deposit Activity:
Number ofofdays
Number daysinin
period
period 90
90
Conversion period (years) 3
Bank's base rate Average Borrowings
8.00% Average Borrowings 4,100,000
4,100,000
% over base rate Loan admin.
2.00% Loan admin.(annual)
(annual) 0.70%
0.70%
Contractual interest rate Risk expense
10.00% Risk expense(annual)
(annual) 1.00%
1.00%
Fees: Average ledger
Average ledgerdemand
demand dep. balance
dep. balance 174,516
174,516
Facility fee Average float
0.125% Average float 60,112
60,112
Conversion fee 0.250%
Required reserve
Required reserveratio
ratio 10.00%
10.00%
Compensating balances
Earnings credit rate 5.10%
% of facility 3.00% Earnings credit rate 5.10%
$ bal req for facility 150,000 Weigh. Avg.
Weigh. Avg. cost
costofofdebt
debt 7.04%
7.04%
% of actual borrowing Percent ofoffinancing
2.00% Percent financingin debt
in debt 92.00%
92.00%
$ bal req for borrowing 82,000 Weigh. marg.
Weigh. marg.costcostofof
debt
debt 6.48%
6.48%
Total Comp Bal Req. 232,000 Bank tax
Bank taxrate
rate 35.00%
35.00%
Banken Industries
Customer Profitability Analysis
Expenses # items ` per unit Cost Total
Demand Deposit Expense
Home debits 4,187 0.23 963.01
Transit items 15,906 0.12 1,908.72
Deposits 90 0.35 31.50
Returned items 33 3.50 115.50
Account maintenance 3 6.75 20.25
Total transaction exp. 3,038.98
Wire transfers 336 2.00 672.00
Security safekeeping 13 4.00 52.00
Payroll processing 3 1,500 4,500.00

Days in Total
Loan expense: Rate Period Amount Expense
Loan administration 0.70% 90 4,100,000 7,076.71
Risk expense 1.00% 90 4,100,000 10,109.59
Interest expense 6.48% 90 4,100,000 65,477.79
Total Expenses ` 90,927
Banken Industries
Customer Profitability Analysis
Days in
Revenues Rate Period Amount
Investment income from:
Ledger balances 174,516
Minus float 60,112
Collected balance 114,404
Minus required reserves @ 10.00% 11,440
Investable balances 102,964
Investment income 5.10% 90 102,964 1,294.80
Fee income 0.13% 90 5,000,000 1,541.10
Loan interest 0 90 4,100,000 101,095.89
Total Revenue ` 103931.79

Days in
Target Profit Rate Period Amount Total
Target pretax return 18.00%
Relevant fin. % of equity 8.00%
Target profit 18.00% 90 4,100,000 14,557.81

Total Profit Req. (Expenses + Target Profit) 105,484.88

Revenue - Expenses + Target Profit ` (105484.88)
 Conclusion
• Customer cost and customer profitability is critical for a bank today.

Knowing total costs for particular processes and activities allows to

focus on reducing and controlling them. Knowing costs for a specific

customer allows to reduce, change or charge for activities/services

provided to them.

• The determination of customer costs and profitability should be

performed using activity based costing techniques. Although it requires

the availability of customer-related data, the calculation is

straightforward.
THANK YOU!