Owners and managers often continue to sell money-losing products out of sentimentality or unwavering optimism. To maximize your business's profitability, you need to be equipped to make an objective decision. Here are some of the factors you should take into account when deciding whether to continue a product line.
When deciding whether or not to discontinue a product, the decision should include the total costs, not just per-unit costs. You should review the fixed manufacturing costs, selling costs, transportation and storage costs, customer service costs and any other cost you can tie to the product. Most of this data should be easily accesible for review if you have a reliable accounting department or bookkeeping service the uses proper cost segregation techniques.
It may come as a suprise that in addition to direct financial costs, maintaining a product also has opportunity costs. The time you spend keeping a product up to date could be put towards researching and launching a new product. The physicial factory capacity or floor space in your store could potentially be used for other products.
When evaluating a product line, always ask — what else could you be doing? This will help keep you from falling behind and missing opportunities to drive growth.
Desired Rates of Return
As a subset of opportunity costs, you should also calculate your desired rate of return. Set goals for both profit margin and overall return on investment based on both your other product lines and benchmarks in your industry.
If a product lags behind, consider whether you can make improvements, increase efficiency or discontinue it for a more profitable product. Even if you can theoretically increase capacity to keep a low-returning product and add a new one, spreading your focus and energy will likely hamper your business's overall performance.
If you're leaning towards discontinuing a product, it's important to consider employee morale. If you suddenly shut down a product line and lay off workers, your remaining workers will feel less secure in their jobs, and their performance may decrease as a result. You may also have difficulty recruiting new talent.
As an alternative, look for a slower transition that shifts affected workers into working on your new product or absorbs them into other areas of your operations.
Complicating the analysis is when one product drives the performance of others. Your poor-performing base product may drive sales of several highly profitable accessories, add-ons or service plans. Often something your business has built a strong reputation for may bring in customers and drive sales of products that aren't directly related, this is your loss leader.
Analyzing these types of opportunities requires two steps. First, track your sales and marketing performance to determine exactly how much the product in question drives other sales. Next, consider the costs and profitability of those connected sales as a whole to decide whether to continue the product as a loss leader or gateway product.
Cannibalization is the opposite of cross-selling where one product may be underperforming because of another. For example, you might have a baseline model and then a slightly more expensive and more profitable upgraded model. While many customers might select the baseline model based on price alone, there's a good chance only offering the upgraded model would result in only a small drop in sales but higher overall profits.To track cannibalization, you can ask customers why they made their choice and consider temporarily halting sales of one product to see if sales of the other increase during that time frame.
As with most business decisions, the key is in understanding your numbers. The better you understand how a product impacts your bottom line, the more informed your decision will be when you need to decide whether to discontinue a product line. If you are interested in measurable outsourced accounting services be sure to schedule a consultation below. From proactive insights and custom financial reporting to third party software recommendations and controller oversight, we don't just handle your accounting needs--we get it done right.