You think all products and customers are profitable, but they’re not. Some products drain profit while others drive it. Some customers cost more than they’re worth. This lack of segmentation prevents you from focusing on what’s actually profitable, which limits profitability improvement.
Margin segmentation solves this by showing you which products and customers are actually profitable. It reveals high-margin segments to focus on and low-margin segments to fix or eliminate, which helps you optimize profitability systematically. This analysis is essential for making informed decisions about products and customers.
This guide provides a data-driven approach to margin segmentation, helping you identify which products and customers drive profitability and which don’t.
We’ll explore how to segment by product and customer, calculate margins for each segment, identify profitable and unprofitable segments, and use segmentation to improve profitability. By the end, you’ll understand which products and customers are actually worth your focus.
Key Takeaways
- Segment by product—calculate margins for each product to identify which are profitable
- Segment by customer—calculate margins for each customer to identify which are profitable
- Identify high-margin segments—focus on products and customers with healthy margins
- Fix or eliminate low-margin segments—improve margins or stop serving unprofitable segments
- Optimize mix—focus resources on profitable segments to maximize overall profitability
Table of Contents
Why Segmentation Matters
Average margins hide the truth. You might have healthy average margins, but some products or customers are highly profitable while others lose money. This averaging masks problems and opportunities, which prevents you from optimizing profitability effectively.
Segmentation matters because it reveals where profit actually comes from. When you segment by product and customer, you see which segments drive profit and which drain it. This visibility helps you focus resources on profitable segments and fix or eliminate unprofitable ones, which improves overall profitability.
The reality: Many businesses discover through segmentation that 20% of products or customers generate 80% of profit, while others are unprofitable. This discovery enables dramatic profitability improvements by focusing on what works and fixing or eliminating what doesn’t.
Product Margin Segmentation
Product segmentation calculates margins for each product to identify which are profitable and which aren’t. This analysis helps you focus on high-margin products and fix or eliminate low-margin ones.
Calculating Product Margins
The process:
- Calculate revenue for each product
- Allocate direct costs to each product
- Calculate gross margin for each product
- Allocate operating expenses to each product (where possible)
- Calculate net margin for each product
Why this matters: Product margin calculation shows which products are actually profitable. If some products have negative margins, they’re losing money. If others have high margins, they’re driving profit. This calculation helps you see the true profitability of each product.
Identifying High-Margin Products
What to look for:
- Products with margins above your average
- Products that contribute significantly to total profit
- Products with strong pricing power
- Products with efficient cost structures
Why this matters: High-margin products drive profitability. If you identify these products, you can focus on growing them, which improves overall profitability. This focus maximizes profit from your product portfolio.
Identifying Low-Margin Products
What to look for:
- Products with margins below your average
- Products with negative margins
- Products that consume resources without profit
- Products that might be better eliminated
Why this matters: Low-margin products drain profitability. If you identify these products, you can fix their margins or eliminate them, which improves overall profitability. This identification prevents unprofitable products from hurting your business.
Pro tip: Use our Profit Margin Calculator to calculate margins for each product. Compare product margins to identify which are profitable and which need improvement. This analysis provides the data you need for product decisions.
Customer Margin Segmentation
Customer segmentation calculates margins for each customer to identify which are profitable and which aren’t. This analysis helps you focus on high-margin customers and fix or eliminate low-margin ones.
Calculating Customer Margins
The process:
- Calculate revenue from each customer
- Allocate direct costs to each customer
- Calculate gross margin for each customer
- Allocate operating expenses to each customer (where possible)
- Calculate net margin for each customer
Why this matters: Customer margin calculation shows which customers are actually profitable. If some customers have negative margins, they’re costing you money. If others have high margins, they’re driving profit. This calculation helps you see the true profitability of each customer.
Identifying High-Margin Customers
What to look for:
- Customers with margins above your average
- Customers who pay full price without heavy discounting
- Customers who require minimal service or support
- Customers who buy high-margin products or services
Why this matters: High-margin customers drive profitability. If you identify these customers, you can focus on growing relationships with them, which improves overall profitability. This focus maximizes profit from your customer base.
Identifying Low-Margin Customers
What to look for:
- Customers with margins below your average
- Customers who require excessive discounting
- Customers who demand more service than they pay for
- Customers who might be better let go
Why this matters: Low-margin customers drain profitability. If you identify these customers, you can improve their margins or stop serving them, which improves overall profitability. This identification prevents unprofitable customers from hurting your business.
Pro tip: Calculate customer lifetime value and margin together. A customer with low margins but high lifetime value might still be worth keeping if you can improve margins. A customer with low margins and low lifetime value should be eliminated. This combined analysis helps you make better customer decisions.
Identifying Profitable Segments
Profitable segment identification helps you focus on what works. By identifying high-margin products and customers, you can prioritize resources and grow profitability systematically.
High-Margin Product Focus
Prioritize profitable products:
- Grow sales of high-margin products
- Invest in marketing and development for profitable products
- Optimize operations to support high-margin products
- Build product strategy around profitable segments
Why this matters: Focusing on high-margin products improves profitability. If you grow sales of products with 40% margins instead of 10% margins, profit increases significantly. This focus maximizes profit from your product portfolio.
High-Margin Customer Focus
Prioritize profitable customers:
- Grow relationships with high-margin customers
- Invest in service and support for profitable customers
- Develop products and services for high-margin customer segments
- Build customer strategy around profitable segments
Why this matters: Focusing on high-margin customers improves profitability. If you grow relationships with customers who provide 30% margins instead of 5% margins, profit increases significantly. This focus maximizes profit from your customer base.
Segment Profitability Analysis
See the full picture:
- Compare margins across all products and customers
- Identify which segments contribute most to total profit
- Assess which segments have growth potential
- Prioritize segments with high margins and growth opportunity
Why this matters: Segment profitability analysis helps you see where profit comes from and where to focus. If 20% of products generate 80% of profit, focus there. If certain customer segments are highly profitable, prioritize them. This analysis guides strategic decisions.
Pro tip: Create a profitability matrix plotting products and customers by margin and volume. Focus on high-margin, high-volume segments first, then high-margin, low-volume segments. This prioritization maximizes profit improvement.
Fixing Unprofitable Segments
Fixing unprofitable segments improves overall profitability. By improving margins on low-margin products and customers, or eliminating them if they can’t be fixed, you stop profit drains and improve average margins.
Improving Product Margins
Fix low-margin products:
- Raise prices on low-margin products
- Reduce costs on high-cost products
- Improve efficiency to reduce costs per unit
- Optimize product mix to eliminate unprofitable items
Why this matters: Improving product margins stops profit drains. If you raise prices on low-margin products or reduce their costs, margins improve. If margins can’t be improved, eliminating unprofitable products improves average margins. This improvement increases overall profitability.
Improving Customer Margins
Fix low-margin customers:
- Raise prices for low-margin customers
- Reduce service costs for high-cost customers
- Negotiate better terms with unprofitable customers
- Stop serving customers who can’t be made profitable
Why this matters: Improving customer margins stops profit drains. If you raise prices for low-margin customers or reduce their service costs, margins improve. If margins can’t be improved, stopping service to unprofitable customers improves average margins. This improvement increases overall profitability.
Eliminating Unprofitable Segments
Stop the drains:
- Eliminate products that can’t be made profitable
- Stop serving customers who can’t be made profitable
- Focus resources on profitable segments instead
- Improve average margins by removing low-margin segments
Why this matters: Eliminating unprofitable segments improves average margins. If you remove products or customers with negative margins, average margins improve immediately. This elimination stops profit drains and frees resources for profitable segments.
Pro tip: Before eliminating segments, try to fix them first. Raise prices, reduce costs, or improve efficiency. If margins still can’t be improved, then eliminate. This approach ensures you’re not giving up on fixable problems.
Optimizing Segment Mix
Segment mix optimization focuses resources on profitable segments to maximize overall profitability. By growing high-margin segments and reducing low-margin segments, you improve average margins and total profit.
Growing High-Margin Segments
Focus resources:
- Invest in marketing and sales for high-margin products
- Develop relationships with high-margin customers
- Expand capacity for profitable segments
- Build strategy around high-margin opportunities
Why this matters: Growing high-margin segments improves overall profitability. If you grow segments with 40% margins, average margins improve. This growth increases total profit more than growing low-margin segments, which maximizes profitability.
Reducing Low-Margin Segments
Minimize resources:
- Reduce investment in low-margin products
- Minimize service for low-margin customers
- Shift capacity away from unprofitable segments
- Focus on profitable segments instead
Why this matters: Reducing low-margin segments improves average margins. If you reduce segments with 5% margins, average margins improve. This reduction stops profit drains and frees resources for profitable segments, which improves overall profitability.
Balanced Segment Strategy
Optimize the mix:
- Balance growth across high-margin segments
- Maintain some low-margin segments if they support high-margin ones
- Optimize product and customer mix to maximize profit
- Ensure overall strategy improves average margins
Why this matters: Balanced strategy optimizes overall profitability. Sometimes low-margin segments support high-margin ones. Sometimes they should be eliminated. Understanding this balance helps you optimize segment mix for maximum profit.
Pro tip: Regularly review segment margins and adjust mix accordingly. As conditions change, segment profitability changes. Regular review ensures you’re always focusing on the most profitable segments, which maintains optimal profitability.
Your Next Steps
Margin segmentation reveals where profit comes from. Segment by product and customer, identify profitable and unprofitable segments, then optimize your mix to maximize profitability.
This Week:
- Calculate margins for each product using our Profit Margin Calculator
- Calculate margins for each customer to identify profitable relationships
- Identify high-margin products and customers to focus on
- Identify low-margin products and customers to fix or eliminate
This Month:
- Improve margins on low-margin products through pricing or cost optimization
- Improve margins on low-margin customers through pricing or service optimization
- Eliminate products or customers that can’t be made profitable
- Focus resources on high-margin segments to grow profitability
Going Forward:
- Make margin segmentation a regular part of business analysis
- Continuously review and optimize segment mix
- Focus growth efforts on profitable segments
- Build segmentation into product and customer strategy
Need help? Check out our Profit Margin Calculator for margin calculation, our margin makeover guide for comprehensive margin improvement, and our revenue vs. profit guide for understanding margin dilution.
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Sources & Additional Information
This guide provides general information about margin segmentation. Your specific situation may require different considerations.
For margin calculation, see our Profit Margin Calculator.
Consult with professionals for advice specific to your situation.
