Which Product Actually Makes Money: Profitability by Line
- A business with three lines
- Allocation 1: by revenue
- Allocation 2: by what drives the cost
- What the result does and does not mean
- Usually the answer is to fix the line, not drop it
- Setting it up in your own business
- Where this fits
To find out which product or service line makes money, first measure each line’s contribution, what it earns after its own direct costs, and then allocate shared overheads using what actually drives those overheads, not simply revenue. Allocating overhead by revenue is the most common method and the most misleading one, because it assumes every rupee of sales consumes the same amount of support, which is rarely true.
The answer changes decisions. A line that looks healthy on a revenue allocation can turn out to be the one quietly eating the profit of the others.
A business with three lines
A distributor sells three product lines. Annual figures, in ₹ lakh:
| Line A: bulk industrial | Line B: trade counter | Line C: online small orders | Total | |
|---|---|---|---|---|
| Revenue | 60 | 30 | 10 | 100 |
| Direct costs | 36 | 15 | 7 | 58 |
| Contribution | 24 | 15 | 3 | 42 |
| Shared overheads | 30 | |||
| Profit | 12 | |||
Direct costs are those that exist only because of that line: the goods sold, packaging, line-specific commissions. Shared overheads are warehouse staff, order processing, customer service, rent and systems.
Allocation 1: by revenue
Split the ₹30 lakh in proportion to revenue: 60%, 30% and 10%.
| A | B | C | |
|---|---|---|---|
| Contribution | 24 | 15 | 3 |
| Overhead allocated | (18) | (9) | (3) |
| Line profit | 6 | 6 | 0 |
On this view C breaks even. Nobody would worry about it.
Allocation 2: by what drives the cost
Now look at what the overhead is actually spent on. In this business most of it is picking, packing, invoicing, dispatch and handling queries, work that scales with the number of orders, not their value. Over the year:
- Line A: 2,000 large orders
- Line B: 1,000 orders
- Line C: 3,000 small orders
Allocate the ₹30 lakh by order count, 6,000 orders at ₹500 each:
| A | B | C | |
|---|---|---|---|
| Contribution | 24 | 15 | 3 |
| Overhead allocated by orders | (10) | (5) | (15) |
| Line profit | 14 | 10 | (12) |
Same business, same total profit of ₹12 lakh. But now A and B are earning ₹24 lakh between them and C is losing ₹12 lakh. Line C generates half of all orders and a tenth of revenue. On a revenue allocation, A and B were subsidising it invisibly.
In practice, overheads have more than one driver. Rent may follow floor space, customer service may follow queries, and accounts may follow invoices. Use two or three drivers for the largest overhead pools. Precision beyond that rarely changes the conclusion.
What the result does and does not mean
The ₹12 lakh loss on C does not mean that dropping C would add ₹12 lakh to profit. That depends on how much of the ₹15 lakh allocated to it would actually go away.
- If dropping C removes only ₹1 lakh of genuinely avoidable cost, the business loses C’s ₹3 lakh of contribution and saves ₹1 lakh. Profit falls by ₹2 lakh.
- If C’s order volume means the business can release two warehouse staff and a courier contract, saving ₹8 lakh, the business loses ₹3 lakh of contribution and saves ₹8 lakh. Profit rises by ₹5 lakh.
The allocation tells you where to look. The avoidable-cost test tells you what to do. This is the same logic as the special-order and product-drop decisions in contribution margin and pricing decisions.
Usually the answer is to fix the line, not drop it
Line C’s problem is cost per order, not the product itself. The practical responses are often better than closure:
- A minimum order value or a small-order charge that reflects handling cost.
- Free shipping above a threshold, which raises average order size.
- Cheaper fulfilment for small orders: batching, a simpler pack, or a different courier.
- Repricing so that the line’s contribution covers the overhead it consumes.
If average order value on C doubled with the same total revenue, orders would halve to 1,500, and the overhead it drives would roughly halve with them.
The same lens often flatters the line people worry about least. Line A’s large orders consume little handling per rupee, which is why it looks much stronger on an activity basis. That is a reason to protect A’s customers, and to be careful before offering them discounts that assume their margin is the same as everyone else’s.
Setting it up in your own business
- Tag revenue and direct costs by line in your accounts. Most software supports cost centres or tracking categories for this.
- List your largest overhead pools and choose a driver for each: orders, invoices, hours, square feet, headcount.
- Record the driver quantities by line for the year.
- Allocate, and compare the result with a revenue-based allocation. Where they differ sharply, investigate.
- Repeat annually, or when the mix of the business changes.
Where this fits
- The decision logic for keeping or dropping a line: contribution margin and pricing decisions
- Separating costs that vary from costs that do not: fixed or variable costs
- Pricing to cover handling: what a discount really costs your margin
- Tools: gross and net profit converter · profit margin calculator