"We're confident our enterprise customers are our most profitable segment."
The CEO said this with conviction, pointing to a polished dashboard showing customer lifetime value by segment. Enterprise customers had the highest revenue per transaction and the most impressive LTV numbers.
Six months later, after implementing activity-based cost tracking, they discovered something that changed everything: their "most profitable" enterprise segment was actually subsidized by the supposedly less valuable SMB customers.
The culprit? A cost allocation methodology that created beautiful fiction instead of strategic truth.
The Allocation Trap
Most organizations calculate customer lifetime value using some version of allocated costs. They take shared expenses—IT infrastructure, facilities, executive time, support functions—and distribute them across customer segments using seemingly logical rules:
IT costs allocated by number of users
Facilities costs spread by headcount
Executive time distributed by revenue
Support costs divided equally across all customers
This approach feels rigorous. It ensures every dollar is accounted for. The spreadsheets balance perfectly.
It's also strategically dangerous.
Allocation creates the illusion of precision while obscuring the actual economics of customer relationships. When you allocate IT costs equally across all product lines, you're making an assumption: that all customers consume technology resources equally. When you spread facilities costs by headcount, you're assuming physical space requirements correlate perfectly with team size.
These assumptions are rarely true. And when they're wrong, they make profitable customers look unprofitable and money-losing relationships appear attractive.
The Real Cost of Spreadsheet Gymnastics
A healthcare technology company struggled to understand why their growth wasn't translating to profitability.
Their allocated cost model showed enterprise healthcare systems as their crown jewel customers—highest LTV, best margins, prime targets for expansion. But when we mapped actual resource consumption:
Enterprise customers required 3x more support hours than allocated models suggested
Their complex integrations consumed 60% of engineering resources while representing 30% of customer count
Sales cycles averaged 18 months vs. 4 months for mid-market customers
Implementation required dedicated project management that never appeared in allocated costs
Meanwhile, their mid-market customers—the ones getting minimal attention because of "lower" LTV—actually:
Generated faster cash conversion
Required minimal custom development
Scaled efficiently with existing infrastructure
Referred new customers at 3x the rate of enterprise accounts
The allocation-based view had them chasing subsidized growth while neglecting their actual profit engine.
Once they redesigned their cost tracking to capture these realities, strategic decisions became clear:
Repositioned enterprise sales to reflect true acquisition costs
Invested in mid-market expansion capabilities
Redesigned support models to match actual consumption patterns
Result: Double-digit percentage growth in revenue and EBITDA without increasing marketing spend. They simply started investing in customers who actually drove profitability.
Beyond Allocation: Designing for Strategic Truth
The alternative to allocation isn't chaos—it's precision. Instead of distributing costs based on convenient proxies, design systems that track actual resource consumption.
Follow the Customer Journey
Map costs to what customers actually do, not accounting convenience. If enterprise customers require custom integrations, track integration costs separately. If certain segments consume more support time, measure support time by segment. If some products demand specialized expertise, track that expertise to the products that require it.
Separate Fixed from Variable
Not all shared costs behave the same way. Some truly are fixed overhead that doesn't vary with customer behavior. Others masquerade as "shared" while actually correlating strongly with specific customer activities.
A client was allocating data storage costs equally across all product lines. When they examined actual usage patterns, one product line consumed 70% of storage resources while another used virtually none. The "equal" allocation was subsidizing the storage-heavy product at the expense of the efficient one.
Design for Decision-Making
Structure cost data to support the strategic decisions you need to make. If you're evaluating market expansion, ensure your cost system can show profitability by geography. If you're considering new product development, track costs in ways that reveal which products actually generate sustainable margins.
Connecting to Your Strategic Framework
This isn't just an accounting exercise—it's fundamental to strategic clarity.
In our Purpose, Perspective, Path framework, bad cost allocation obscures your Perspective. When you can't see which customers actually drive profitability, you can't make informed decisions about where you're going or how to get there.
Purpose: Why does this business exist? If you're optimizing for customers who don't actually generate value, you're not fulfilling your purpose efficiently.
Perspective: Where are we going? Market expansion decisions based on fictional profitability data will take you in the wrong direction.
Path: How are we going to get there? Resource allocation, pricing strategies, and operational investments all depend on understanding true customer economics.
The Questions That Matter
Before you trust your next customer profitability analysis, ask:
Can you trace 80% of costs directly to specific customer activities? If most costs are "allocated," you're working with fiction.
Do your "shared" costs actually vary with customer behavior? Many costs that seem fixed actually scale with specific customer requirements.
Would your strategic decisions change if allocation methods changed? If shifting from headcount-based to revenue-based allocation would alter your strategy, your strategy isn't based on reality.
Can you explain cost differences between customer segments without using the word "allocated"? If not, you don't understand your customer economics.
Making the Right Thing the Easy Thing
The goal isn't perfect cost accounting—it's strategic insight. Design cost systems that make accurate customer profitability assessment the easy default, not a complex exception.
Start with your highest-impact decisions. If you're evaluating customer segments for expansion, ensure your cost data supports that decision. If you're designing pricing strategies, track costs at the level where pricing decisions get made.
Remember: allocation is convenient, but convenience that misleads strategic decisions isn't convenient at all.
The companies that will thrive in the next decade aren't those with the most sophisticated spreadsheets. They're the ones with the clearest view of their actual customer economics—and the courage to make decisions based on that truth, even when it challenges comfortable assumptions.
Your customer lifetime value calculations are only as good as the cost data beneath them. Make sure you're building strategy on bedrock, not quicksand.