Hierarchy levels of revenue and costing positions

In this section, the various hierarchy levels shall be illustrated on which the cost and revenue relevant positions should be recorded, e.g. products, orders, customers, market segments and companies. The costs are recorded on each level, whereby these should be differentiated regarding their reduction ability within the reference time period in order to supply decision-relevant costing information.

The following diagram illustrates the process in detail:

Costing hierarchy

Diagram 2: Costing hierarchy

The product level costs are existent in the majority of enterprises (break-even analysis) and cause no additional expense. Order based costing is mainly determined through the number of orders processed, order value, shipping costs and the number of tenders necessary for the order. At the customer level, costs incur, which are determined by customer specific product adjustment, performance of customer specific services, discount agreements and delivery conditions. Costs furthermore arise for acquisition (e.g. introductory offers, free gifts, visiting customers), customer care, (e.g. data administration, dunning, credit assessment, customer service) and maintaining customer relations.

Within the field of market segments costs may insure, which are not cost reflectively assigned to individual customers but to a market segment, such as advertising expenditure of certain market segments. On the highest level of the hierarchy costs that are recorded until now could not be cost reflectively assigned. These mainly concern stand-by costs such as personnel and controlling divisions, management as well as rent and depreciation of the company building.

Calculating a differentiated customer profit contribution via activity- based costing

After the calculation of relevant costs at the individual levels of the hierarchy, the customer profit contribution may be determined for a period defined in advance. First, the sales realized from a customer within the reference period are recorded. Next, sales deductions (e.g. discounts, cash discounts) are deducted to obtain the net revenue. In the next step, the various cost positions are successively subtracted from the net revenue. The following diagram explains the procedure more in detail:

Customer costing through activity- based costing

Customer sales


Customer sales deductions

Customer net revenues

Customer net revenues


Direct product costs


Direct order costs


Direct customer costs


Customer profit contribution I

Product processing costs

Order processing costs

Customer processing costs

Customer profit contribution II

Diagram 3: Calculating the customer profit contribution

For calculating the customer profit contribution I, the direct customer-specific costs of the reference factors product (standard production costs and if applicable, costs for customer-specific product adjustments), order and customer are deducted from the net customer revenue. In doing so both the variable and fixed (direct) costs realized through the customer relationship are taken into account. In order to calculate the customer profit contribution II, the process costs of the product, order and customer hierarchy levels are subtracted from the customer profit contribution I. At this point "costs for non-required capacities" are deducted. These result from the fact that the process cost rate for the reference object is calculated based on the maximum process available quantity, and not on the budgeted or actually completed process quantity. These costs should however, only be calculated if a causative correlation between "costs for non-required capacity" and the reference object (product, customer, order, market segment) is apparent. Costs for non-required capacity are described as being all costs arising through resources that are only running at partial capacity and may be calculated by using the following formula:

Costs for non-required capacity = process cost rate * (maximum possible process quantity - actual conducted process quantity)

Interpretation of customer profit contributions

As only cost positions that are recorded as direct costs flow into the customer profit contribution I, this contribution margin directly illustrates the proportion of the result achieved in the reference period that would not have been realized without the existence of this customer relationship. Due to the missing allocation of indirect costs according to the distribution ratio, the customer profit contribution I reflects the customer profitability and thus provides a solid aid for the decision-making regarding the composition of a profitable customer base. It should however be taken into account that the individual cost positions could in some circumstances include fixed (direct) costs (e.g. the key account manager's salary, who looks after the key accounts), which cannot be reduced during the observed period.

The customer profit contribution II results after the deduction of the indirect costs assigned to the customer through activity-based costing. A portion of these indirect costs e.g. salaries in indirect sectors (billing, dunning, customer service, order processing etc.), can even after the dissolution of the customer relationship, not be reduced. Therefore, the customer profit contribution II should mainly be interpreted as an indicator for the customer-specific demands on the enterprise resources. The customer profit contribution II enables a recognition of which customer or customer groups require more of the company resources than it is justified based on the realized turnover volume. This means the customer profit contribution II can be used to aid the strategic planning, as it aids the recognition of starting points for increasing the profitability.

The customer profitability changes through the entire cycle of the customer relationship. At the beginning of a business relationship, e.g. because of high acquisition costs, expenses may exceed the realized revenue. In later phases of the business relationship, this will ideal typically be reversed and generally a profit is realized.9 If in interpreting customer profit contributions the phase (of life) in which the customer relationship finds itself is not taken into consideration, it can lead to erroneous decisions being made, such as the premature ending of a customer relationship on the basis of negative contributions.

When interpreting customer profit contributions, it should be considered whether the data is calculated using historical cost and revenue positions or using forecasted data. Past data allow in principle no extrapolation to the future viability of the customer, as both the demand behavior of the individual customer and the demands on company resources, the competition environment and the production program of the company may change over time. Therefore, market research data and analyses such as future demand behavior, general economic development and customer-specific demand for products coming new onto the market should additionally be incorporated when interpreting customer profit contributions.

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