Segment Margin Definition
Segment Margin is important to a company because, most obviously, companies make profits off of their services and products. To acquire revenue from these services and products, a company would use a segment margin in order to determine whether the product has enough economical worth to continue producing. Therefore, it makes sense to provide an example so that segment margin can be viewed in a real life situation. An segment margin example is provided below.
Example And Explanation of Segment Margin
A shoe company, Fastbrink Shoes, has many different lines of shoe products and memorabilia that they sell to the public in order to make a profit. Because there are so many products, Fastbrink decides that they are going to trim down the number of products so that the most profitable and marketable products are getting the most attention. At the same time, they also want to eliminate the products that do not earn as much revenue as the more popular models and products. In one such case, Fastbrink has a line of basketball shoes that comes in two different colors, blue and black. Fastbrink wants to decide which shoe to keep and which shoe to scrap. Fastbrink will do this by calculating the segment margin for each shoe to determine which is the more profitable.
Segment Margin Calculation
It must be noted, first of all, that segment margin is calculated by taking the segment revenue of a product. This is essentially the revenue that is produced by a single product by itself. You then subtract the variable costs from the segment revenue and finally subtract the total avoidable fixed costs from that number to decipher the segment margin of a product. For this situation, the segment revenue for the blue shoe is $40,000 for the quarter while the revenues for the black shoe total $35,000. The variable costs for the blue and black shoes are $13,000 and $10,000 respectively. Finally, the avoidable fixed cost for both shoes is $10,000 for labor, parts, and machine maintenance. When calculated completely, the segment margin for the blue shoe comes out to be $17,000. Whereas, the black shoe segment margin totals $15,000.
Because the blue shoe rakes in $2,000 dollars more revenue that the black shoe, Fastbrink decides to discontinue the black shoe. As a result, profits on the blue shoe (more profitable model) can be maximized.
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