Customer profitability and the rebate cliff at Brightline Office Supplies
Brightline Office Supplies distributes to 620 business customers. Revenue is £12.4m and operating profit £310k. A pilot activity-based costing exercise on the three largest accounts used these rates: £75 per order, £140 per delivery, £15 per returned item, and £8,000 per year for a dedicated account manager where one is assigned. The three accounts are:
| Account | Revenue | Gross margin | Orders | Deliveries | Returns | Dedicated manager |
|---|---|---|---|---|---|---|
| A | £2.40m | 22% | 120 | 110 | 40 | No |
| B | £410k | 26% | 780 | 760 | 260 | Yes |
| C | £38k | 30% | 210 | 205 | 90 | No |
Sales staff are paid commission on revenue. Brightline also receives a 4% rebate from suppliers when annual purchases exceed £7.5m; purchases are currently £7.8m and cost of sales is 74–78% of revenue across the three accounts. The finance director wants to rank the customers and exit the loss-makers.
1. Calculate the profit after cost-to-serve for accounts A, B and C, expressed in £ and as a percentage of revenue, and comment on what the figures show.
Read the worked answer
Account A
Gross margin: £2,400,000 × 22% = £528,000
Costs: (120 × £75) + (110 × £140) + (40 × £15) = £9,000 + £15,400 + £600 = £25,000
Profit: £503,000 (21.0% of revenue)
Account B
Gross margin: £410,000 × 26% = £106,600
Costs: (780 × £75) + (760 × £140) + (260 × £15) + £8,000 = £58,500 + £106,400 + £3,900 + £8,000 = £176,800
Profit: −£70,200 (−17.1% of revenue)
Account C
Gross margin: £38,000 × 30% = £11,400
Costs: (210 × £75) + (205 × £140) + (90 × £15) = £15,750 + £28,700 + £1,350 = £45,800
Profit: −£34,400 (−90.5% of revenue)
The pattern is driven by order economics, not gross margin. A averages £20,000 per order; B averages £526 and C £181. B and C carry high margins as a percentage but each order triggers handling and a delivery that costs more than the margin it earns. C's returns rate (0.43 per order) is also higher than A's or B's (0.33). A is effectively subsidising the small-order tail, and revenue-based commission actively encourages sales staff to recruit more customers like B and C.
2. Evaluate the finance director's proposal to rank customers and exit the loss-makers. Recommend an alternative, supporting your answer with the rebate calculation and non-financial considerations.
Read the worked answer
The rebate calculation
Removing B and C reduces purchases by roughly their cost of sales: B £410,000 × 74% = £303,400; C £38,000 × 70% = £26,600; total £330,000. Purchases fall from £7.8m to about £7.47m, below the £7.5m threshold, so the 4% rebate on roughly £7.47m - about £299,000 - is lost. That is nearly three times the £104,600 of losses removed. Exiting both accounts would make the group worse off, and little fixed cost would actually disappear: the account manager can be redeployed, but the vans and warehouse remain.
Alternative
- Re-price rather than exit: minimum order value (say £250) or a small-order surcharge, and a delivery charge for drops below a threshold.
- Move B to a consolidated weekly delivery and an online ordering portal; its order frequency, not its size, is the problem.
- Introduce a returns authorisation fee and analyse why C returns so much.
- Change sales commission to gross profit after cost-to-serve, so new accounts are won on profitable terms.
- Treat exit as a last resort, and only after modelling the rebate and any customer concentration risk.
Non-financial factors
B may be a reference customer in its region; C may be a route into a larger buying group; both provide volume that supports supplier terms and warehouse utilisation. Ranking on activity cost alone ignores these, and the pilot covers three of 620 accounts - the remaining tail must be analysed before any structural decision is taken.