Segmenting Customers for Profit

Segmenting Customers for Profit

Segmenting Customers for Profit Process

Market segmentation is the process of dividing up the total market based on identifiable characteristics, which have common needs. You can also apply the concept of market segmentation to your customers. For example, you can segment your customers based on the cost to service, the size of the average sale or the number of transactions.
Though segmenting customers for profit or customer segmentation is a simple concept, it is not simple to implement in any meaningful way. The difficult part is identifying the various segments so that you can identify profitable customers versus those that can cost you time and money.

Customer Segmentation – Vertical or Horizontal

Customers may be segmented either horizontally or vertically.
Horizontal segmentation is where you divide customers by industry, geographic location or revenue size.
Vertical segmentation is where you might sell numerous services or products to just one particular type of customer.
For example, you might sell to customers in the construction industry numerous products, such as, steel, lumber and doors to that customer. Though segmenting customers based on market characteristics is useful, you might also segment your customers based on servicing characteristics (i.e.: size of order number of transactions or total sales volume).

Profitability Analysis By Customer

Once you have identified the various segments that apply to your customers you then perform a profitability analysis by customer. Take your annual sales by customer and break it out into various segments. Identify any patterns or relationships which might indicate opportunities for improvement. For example: a large number of small customers or concentration of large ones.

Customer Profitability Analysis

Next, perform a customer profitability analysis by subtracting your estimated relative cost to service from the revenue for the various segments. Estimating the cost to service may be done in general terms on a scale of one to five or in specific terms using activity-based costing. By relating your cost to service to your revenue streams, you can often identify “profit drains” that can be restructured. This restructuring might involve raising prices on select customers, implementing price discounts, sales incentives or firing customers.
If you want to learn how to price for profit, then download our Pricing for Profit Inspection Guide.
segmenting customers for profit
[box]Strategic CFO Lab Member Extra
Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs[/box]
segmenting customers for profit

Recommended reading: The Strategy and Tactics of Pricing, Fourth Edition, by Thomas T. Nagle and John E. Hogan
See Also:
Segment Margin
Activity Based Costing vs Traditional Costing
Implementing Activity Based Costing
Profitability Index Method
Net Profit Margin Analysis
Gross Profit Margin Ratio Analysis

Related Blogs
Does your Accounting Department Produce Net Income?

Coaching the Entrepreneur: Learn how to know what you don’t know. How much should I spend on accounting for my company?     I have been in the accounting profession for 32 years, and for the last 6 years, I’ve owned my own consulting firm to assist companies with accounting challenges. There is one common theme that I

Read More »
Near Sourcing vs. Outsourcing: The Key to Cost-Effective Accounting Solutions

In this insightful interview, Dan sheds light on the critical role of accounting in business growth and success. Uncover the common pitfalls business owners face when overlooking accounting and how it can hinder access to loans and financial opportunities. Learn why good financial statements are vital for decision-making and attracting investors. With the NearSourcing model,

Read More »
Is Mexico the New China?

In the wake of the COVID-19 pandemic and escalating tensions with China, American companies are actively seeking alternatives to mitigate their supply chain risks and reduce dependence on Chinese manufacturing. Nearshoring, the process of relocating operations closer to home, has emerged as an explosive opportunity for American and Mexican companies to collaborate like never before.

Read More »
WIKI CFO® - Browse hundreds of articles
Skip to content