Chapter 6: Business Segmentation

A segment is a component of a business that is or will generate revenues and costs related to operations. Financial information should be available for a segment's activities and performance and must also be periodically reviewed by the company's management before a decision can be made regarding the amount of capital that will be given to the segment for a particular operating period.

                                                                                                                Source: Investopedia

Quite big definition. I have a smaller one, easy to remember and simple to understand. Definition is ‘Divide and Rule’. This chapter is specifically for those businesses which are

• Involved in producing different types of products and providing different types of services
•  Doing business in different geographical location
• Type of consumers- e.g. retail and wholesale, consumers in different age group etc

By and large these are the only two basic criteria on which a business can be segmented. Rest all types of segmentation are just different versions of above two. Let’s take an example of a company in FMCG sector.

Company A is in FMCG sector. Its product portfolio includes bathing soap, shampoo, biscuits, juices, chocolates, fairness cream, shaving cream and dishwash bar. This business can be bifurcated into three segments.

Company A can measure performance by analyzing profitability of these three segments.

Fig in USD Mn

Particulars	Food Items	Beauty and Skincare products	kitchenware product	Total
Sales	150	600	750	1500
Direct cost	80	450	800	1330
Direct cost % to sales	53%	75%	107%	89%
Gross Profit	70	150	(50)	170
Gross Profit % to sales	47%	25%	-7%	11%

11% of gross profit on a revenue of USD 1500 Mn. Now if management wants to find out ways to increase profitability both in terms of margin percentage and absolute margin numbers it should drill down in to segments.

As you can see in above pie chart kitchenware products contributes to 50% of the company’s total sales, but if you look at the gross profits of each segment this segment is eating into company’s profits. If company A abandons this segment, scenario would look like this

Particulars	Food Items	Beauty and Skincare products	Total
Sales	150	600	750
Direct cost	80	450	530
Direct cost % to sales	53%	75%	71%
Gross Profit	70	150	220
Gross Profit % to sales	47%	25%	29%

In the new scenario the sales has come down to USD 750 Mn but now margins have improved both in terms of absolute numbers and percentage. Now among the two segments food items segment is much better in terms of percentage but that does not mean that the other segment should be abandoned. Although the gross margin percentage of beauty and skincare segment is lower than food items segment, in absolute terms this segment is generation more gross margin. Beauty and Skincare segment is in mature stage (Chapter 3: Life Stages (Part 3)) because of which the volume of gross margin is quite substantial.

This segmentation helps management to find out area which needs more improvement. Management can find out which segment is helping the company to compete in the market. E.g. Harley Davidson in its early stages to face competition from one its major competitor Indian Motorcycle introduced vehicle for mail delivery apart from its main product.

Divide and Rule is very old strategy which was used in wars but its useful today also that too in business.