A note on the whale curve of customer profitability analysis

A note on the whale curve of customer profitability analysis

 

Highlight 4 main ideas of the whale curve of customer profitability analysis in advanced management accounting.

Four main ideas

1.    It ranks customers by profitability, not by sales revenue.
In customer profitability analysis, each customer is evaluated using revenue less the costs of products, services, selling, distribution, support, administration, and other activities required to serve that customer. Customers are then ranked from the most profitable to the least profitable.

2.    It plots cumulative profitability against cumulative customers.
The horizontal axis shows the cumulative percentage of customers, ordered from most to least profitable. The vertical axis shows cumulative profit, usually expressed as a percentage of total reported customer profit. This produces the characteristic “whale” shape.

3.    A minority of customers usually generates more than 100% of total profit.
The most profitable 20% of customers may generate approximately 150%–250% of total profit, with some examples showing about 180%. The curve rises above the 100% “sea level” because these customers compensate for losses generated elsewhere.

4.    Unprofitable customers can destroy part of the profit created by profitable customers.
The middle group may be broadly break-even, while the least profitable customers cause the curve to fall back toward 100% of actual company profit. The analysis therefore supports strategic decisions such as redesigning service levels, changing prices, reducing cost-to-serve, renegotiating terms, or discontinuing selected customer relationships.

Simple illustration

Suppose a company reports total customer profit of HK$1 million:

• The top 20% of customers generate HK$1.8 million.
• The middle 60% approximately break even.
• The bottom 20% lose HK$800,000.

The company still reports HK$1 million overall, but the whale curve reveals that the bottom group is consuming 44.4% of the profit generated by the top group. Thus, the main managerial insight is not simply “how much profit does the company make?”, but “which customers create, preserve, or destroy that profit?”

 

(source: Hansen 2025)

What can be the reasons for a company to keep the unprofitable customers with reference to the whale curve and what are the business risk if the main profit (e.g. 50% of total corporate profit) of the company is contributed a very small percentage of customers, e.g. 5% of total number of customers)?

A whale curve does not automatically imply that every unprofitable customer should be abandoned. It indicates that the company should understand why the customer is currently unprofitable and decide whether the relationship has strategic, future, or indirect value.

Why retain unprofitable customers?

1.    They may support profitable customer relationships.
A customer may be unprofitable on a stand-alone basis but form part of a wider account portfolio. For example, a small subsidiary may be loss-making while its parent company is highly profitable. Terminating the subsidiary could jeopardize the entire corporate relationship.

2.    They may provide future profit potential.
A new customer may initially require substantial acquisition, onboarding, training, or implementation costs. The whale curve reflects current or historical profitability; it may not capture the customer’s lifetime value. Retention can be justified if the customer is expected to become profitable through higher future purchases, improved product mix, or lower service costs.

3.    They may have strategic importance.
Some customers create benefits that are not fully recorded as current profit, such as:

o   prestige and reference value;

o   access to a new market or industry;

o   product-testing opportunities;

o   market intelligence;

o   referrals and network effects;

o   support for entering a new geographic market.

4.    They may help utilize spare capacity.
If the company has unused production, warehouse, delivery, or employee capacity, serving an apparently unprofitable customer may still contribute toward fixed costs. However, this argument is valid only when the customer does not displace a more profitable order.

5.    They may be important for relationship or public-policy reasons.
Banks, hospitals, universities, utilities, and public-service organizations may retain loss-making customers because of fairness, inclusion, contractual, regulatory, or social responsibilities. A narrow accounting decision based only on customer margin could conflict with these obligations.

6.    The reported loss may reflect an inaccurate cost allocation.
Customer profitability analysis depends on the treatment of indirect and activity costs. A customer may appear unprofitable because general overheads, shared resources, or estimated service costs have been allocated using inappropriate drivers. Activity-based costing and customer-level activity analysis should therefore be reviewed before ending the relationship.

7.    The customer may be commercially or legally difficult to replace.
A loss-making customer may still provide stable volume, market presence, or bargaining strength. The company should compare the customer’s profitability with the opportunity cost of replacing the volume and the costs of finding and serving another customer.

Risks of depending on 5% of customers for 50% of profit

If only 5% of customers generate half of total corporate profit, the left-hand side of the whale curve is very steep. This represents a potentially valuable customer portfolio, but also a serious concentration risk.

Business risk	How the risk may arise
Customer loss	The departure, insolvency, or switching of one major customer could cause a disproportionate fall in profit.
Bargaining-power risk	Highly profitable customers may recognize their importance and demand lower prices, better credit terms, higher service levels, or customized products.
Revenue and margin volatility	A change in order volume, product mix, contract renewal, or purchasing policy among these customers can materially affect results.
Forecasting risk	Corporate budgets and forecasts may become unreliable because they depend on the decisions of a very small number of accounts.
Competitive imitation	Competitors may target the company’s profitable customers with discounts, superior service, or customized solutions.
Relationship-management risk	The loss of one key account manager or senior relationship owner may weaken a strategically important customer relationship.
Operational dependence	The company may adapt its production, logistics, technology, or staffing around the needs of a few customers, reducing flexibility.
Credit and liquidity risk	If a major customer pays late or fails, the company may face a cash-flow problem even when reported annual profit remains positive.
Strategic neglect of the wider base	Management may focus excessively on the top 5% and fail to develop the middle group or reduce losses among the unprofitable group.
Ethical and governance risk	Powerful customers may receive excessive discounts or preferential treatment, creating inconsistent pricing and internal control concerns.

Important interpretation of the 50% figure

The 50% should be interpreted carefully. If the top 5% generate 50% of reported total corporate profit, they are not necessarily generating 50% of the company’s economic value. Their profitability may depend on:

• shared infrastructure funded by other customers;
• costs not captured at the customer level;
• unusually favourable short-term market conditions;
• discounts or concessions granted elsewhere in the portfolio;
• accounting assumptions concerning overhead allocation.

The company should therefore perform sensitivity analysis. For example, management could estimate the effect on profit if:

• the largest customer reduces purchases by 10%, 20%, or 30%;
• the largest customer is lost completely;
• prices fall by 5%;
• service costs rise by 10%;
• payment is delayed by 30 or 60 days;
• a competitor wins one major contract.

Appropriate management response

The objective should not be simply to retain all customers or remove all unprofitable customers. A better response is to segment customers into strategic categories:

1.    Protect: highly profitable and strategically important customers.

2.    Develop: currently modestly profitable or unprofitable customers with realistic growth potential.

3.    Reprice or redesign: customers whose losses arise from discounts, excessive customization, small orders, returns, or costly service requirements.

4.    Manage selectively: customers retained for capacity utilization, market access, social obligations, or portfolio reasons.

5.    Exit or deprioritize: customers that remain structurally unprofitable, have little strategic value, and cannot accept revised prices or service conditions.

Typical corrective measures include minimum-order quantities, delivery charges, revised service-level agreements, digital self-service, fewer customizations, revised payment terms, product-mix changes, and activity-based pricing. The aim is to steepen the profitable part of the whale curve, convert suitable break-even customers into profitable ones, and reduce the loss-making tail.

The central advanced-management-accounting insight is that the whale curve is both a profitability diagnostic and a risk indicator: it shows where profit is created, where it is destroyed, and how vulnerable the company is to dependence on a small group of customers.

A side issue: how to analyse the item of customer discount in customer profitability analysis, e.g. different sales discounts for different customers?

Customer discounts should be analysed as a reduction in realised customer revenue, not merely as a sales department expense. The key question is: after all discounts and the costs of serving the customer, does the customer still generate an acceptable margin?

1. Use a price or revenue waterfall

For each customer, begin with the standard or list-price value and deduct every form of price concession:

List-price revenue − invoice discounts − volume rebates − promotional allowances − early-payment discounts − credit notes and claims − returns and free goods = Net realised revenue

This is often called the pocket-price or revenue waterfall. It shows the gap between the nominal price and the amount the company actually collects.

For example:

Item	Customer A	Customer B
List-price sales	HK$1,000,000	HK$1,000,000
Contract discount	(50,000)	(120,000)
Volume rebate	(20,000)	(50,000)
Promotional support	(10,000)	(40,000)
Early-payment discount	(5,000)	(10,000)
Net realised revenue	HK$915,000	HK$780,000

Although both customers generate the same list-price sales, Customer B produces HK$135,000 less realised revenue because of the larger discount package.

2. Calculate customer profit after the discount

The discount should then flow into customer profitability:

Customer contribution = Net realised revenue − cost of goods sold − customer cost-to-serve

Customer cost-to-serve may include:

• order processing and invoice administration;
• picking, packing, and delivery;
• special or urgent deliveries;
• returns and warranty handling;
• sales visits and account management;
• technical support and training;
• customization or engineering;
• credit-control and collection costs;
• inventory and working-capital costs.

Activity-based costing is useful because it assigns such costs according to the activities actually consumed by each customer rather than spreading them evenly across customers.

Example

Assume that after discounts:

• Customer A’s net realised revenue is HK$915,000.
• Customer B’s net realised revenue is HK$780,000.
• Both have product cost of HK$600,000.
• Customer A’s cost-to-serve is HK$100,000.
• Customer B’s cost-to-serve is HK$150,000.

Customer A contribution= 915,000 − 600,000 − 100,000 = HK$215,000

Customer B contribution = 780,000 − 600,000 − 150,000 = HK$30,000

Thus, the company should not conclude that the two customers are equally attractive merely because their list-price sales are equal.

3. Distinguish types of discount

Different discounts have different managerial meanings and should be analysed separately.

Discount type	Possible rationale	Key analytical question
Negotiated customer discount	Customer size, competition, or bargaining power	Does the volume justify the lower unit margin?
Quantity discount	Larger orders or annual volume	Does the additional volume cover the discount and extra capacity used?
Promotional discount	Product launch or short-term demand generation	Did the promotion generate incremental profitable sales?
Channel allowance	Support for distributors or retailers	What market access or services does the channel provide in return?
Early-payment discount	Faster cash collection	Is the cash-flow benefit greater than the price reduction?
Rebate or retrospective bonus	Achieving annual purchase targets	Did the customer actually produce the expected incremental contribution?
Service-related concession	Compensation for delays or quality problems	Is the discount correcting an internal failure or becoming a permanent expectation?

This prevents the company from treating every discount as equivalent. A discount that increases profitable volume may be economically sound, while a discount that merely rewards purchases the customer would have made anyway represents margin leakage.

4. Analyse discount effectiveness

For each customer, product, order, or contract, management should examine:

• discount percentage as a proportion of list-price sales;
• discount amount per unit;
• change in volume after the discount;
• incremental contribution generated;
• customer cost-to-serve after the discount;
• profitability compared with the price before discount;
• profitability compared with alternative customers or uses of capacity;
• whether the discount is temporary, contractual, or permanent.

A useful incremental test is:

Incremental contribution=Incremental net revenue−Incremental variable cost−Incremental cost-to-serve

A discount is economically justified only when the incremental contribution and strategic benefits compensate for the reduction in price.

For example, if a 10% discount increases sales by only 2%, it may destroy margin. If it enables the company to utilize spare capacity and the incremental cost is very low, however, the same discount might be acceptable.

5. Link discounts to the whale curve

Discounts can substantially change the shape of the whale curve. A customer that appears highly profitable using gross sales may move down the curve after deducting:

• negotiated discounts;
• rebates;
• free delivery;
• special packaging;
• high return rates;
• extended payment terms;
• excessive customer-service requirements.

Therefore, the whale curve should ideally be based on net realised revenue and customer-level cost-to-serve, rather than on invoiced sales alone. The resulting analysis may show that some high-revenue customers are only marginally profitable or even unprofitable.

6. Recommended management controls

A company can manage discount-related profitability through:

1.    Discount approval limits: require higher approval for discounts above specified thresholds.

2.    Customer-specific price floors: set a minimum acceptable margin after cost-to-serve.

3.    Separate discount codes: record negotiated discounts, rebates, promotions, freight concessions, and claims separately.

4.    Quarterly price-waterfall reviews: monitor whether the gap between list price and realised price is widening.

5.    Conditional discounts: link concessions to minimum order size, annual volume, payment speed, or reduced service requirements.

6.    Customer profitability dashboards: show revenue, discount rate, gross margin, cost-to-serve, and pocket margin together.

7.    Post-promotion evaluation: compare actual incremental profit with the profit that would probably have occurred without the promotion.

The main principle is that a customer discount should be evaluated as an investment in customer behaviour, not simply as a reward for sales volume. If the discount does not generate sufficient incremental volume, strategic access, faster cash collection, or lower service costs, it may move an apparently profitable customer toward the loss-making tail of the whale curve.

** references:  a collection of management accounting notes; a useful generative AI tool.