Finding out how much profit a customer is generating for your SaaS business is important for many reasons. Going beyond Customer Lifetime Value (CLTV), which simply tells you how much revenue a customer is contributing to the business, customer profitability analysis takes you one step further and calculates total profit.
You want to know overall profit because it tells you which customers are most worthwhile for the business. High-profit customers deserve top-tier customer service and your marketing team will want to find others like them. SaaS companies can grow faster if they can identify their least profitable customers and find ways to reduce costs.
Alarmingly, some customers just won’t be profitable for your business at all. The worst offenders should potentially be cut loose from your business to prevent the loss of any more money.
What Is Customer Profitability Analysis?
Customer profitability analysis is quite simply a way of working out how much money an individual customer or customer segment generates for your SaaS business. The costs of acquiring and retaining these customers are less than the revenue that results from that customer, meaning that they contribute more to the business than they cost.
SaaS businesses pay attention to customer profitability analysis because it tells them which high-value customers they should focus on, helps them develop accurate pricing plans, and identify where unnecessary expenses are being incurred.
Sometimes, SaaS businesses will want to charge unprofitable customers more, or stop doing business with them entirely. It’s your choice to decide whether some customers are worthwhile for your business, or whether your product is just not a good fit for them.
What are the Benefits of Customer Profitability Analysis?
Customer profitability analysis has many benefits. Here are just a few.
Retain more customers in the long-term
When customers are associated with high profitability, businesses can focus on providing them with top-tier customer service and assigning them dedicated customer success managers. Customers who are more worthwhile to your business can benefit from more care from your customer-facing teams to ensure that they never consider looking for an alternative solution.
Reduce costs associated with serving customers
When you find out who your most expensive customers are, it may be that you can make productive changes within your business to lower the cost of serving them. Perhaps they encounter a recurring problem with your software that could be solved by your development team. Perhaps a self-service portal would help deflect many of the more common service queries that your customers are submitting to your support team.
Helps target your marketing efforts
If you segment your customers based on shared attributes this helps your marketing team identify new leads with enhanced profitability. Instead of wasting time chasing low-value customers, marketers can now focus their efforts on attracting highly profitable customers who represent more value for your business.
How to Calculate Customer Profitability?
There are two phases to go through when calculating customer profitability.
First, find out the annual profit from your customer which is total revenue minus total expenses. The formula goes like this:
Annual profit = (Total revenue generated by the customer in a year) – (Total expenses incurred to serve the customer in a year)
Revenue comes from recurring revenue, upgrades, upsells and cross-sells. Expenses cover things like customer service, customer success, and maintenance costs.
Finally, CPA is the annual profit multiplied by the number of years the customer has been with the company.
The formula goes like this:
CPA = (Annual profit) x (no. of years customer stays with company)
How to Perform Customer Profitability Analysis in 4 Steps
1. Uncover all of your customer costs
You’ll need to focus on the customer journey and analyze exactly when and how customers interact with you. This includes marketing, sales, customer success and customer support. It’s important to know exactly how much each of these functions cost and add them up to find out how they impact on customer profitability.
2. Perform customer segmentation
Customer profitability analysis is most effective when you segment your customers into groups based on shared attributes such as feature usage, product tier, industry and more. You use these segments to find out which groups of customers are most profitable. Use this insight to target your strategy to retain and grow high-value segments of your customer base.
3. Work out each segment’s profitability
Next, work out each segment’s profitability by first finding out the revenue of each segment. You’ll want to add together the revenue for each individual customer and find the total. Once you’ve done that, calculate the profitability of each segment by subtracting the costs from your total revenue.
4. Calculate profitability based on data
You might find out that some of your subscription plans are much more profitable than others. It might be in your interests to retire your most low-value plan and incentivize customers to move to a more profitable plan using one-time discounts. It’s important to use data to understand why certain customer segments are more profitable and use it to move them in a more valuable direction.
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4 Strategies to Maximize Customer Profitability
1. Implement self-service resources
Customer service costs can be dramatically reduced by implementing self-service resources. A self-service help center with guides and tutorials can deflect many customer tickets and empower users to learn on their own.
2. Funnel users into higher tiers
When users reach the limit of their plan, instead of simply ignoring them you can prompt them to upgrade their account to a higher tier to increase their limits, expand their number of seats, or access extra features.
3. Eliminate users who are not cost-effective
Customers who are costing your SaaS business can be gently let go, or downgraded to plans with less support. Focus your efforts instead on those high-value customers who provide a good return for your business.
4. Enhance onboarding to reduce churn
You want to extend a customer’s relationship with you and that means helping them complete onboarding successfully. Collect data about your customer to make the process personalized and interactive and increase trial to paid conversion rate.
It might seem harsh but no business can survive without becoming and remaining profitable. SaaS businesses in particular should be wary of becoming stuck with unprofitable customers who drag down your overall profits and endanger your business’s health. Customer profitability analysis helps SaaS businesses understand when to be ruthless, and how they can take positive action and maximize the returns on particular customer groups.