The business environment is very much dynamic. And so, to diversify the risks, businessmen generally opt for multiple related product lines. With the passing period there comes a point when it is required to discontinue certain product line and it becomes difficult for the businessman to take “keep or drop a product line decision”.
In this decision making, a businessman has to keep a check of various non-financial considerations like
Contents
Synergy benefits of such product:
One of the classic examples to be taken here could be of printer and cartridges. Selling a printer even a loss could be advisable to the company. As income from profit-making segment – cartridges would be recurring.
Social credibility attained through the same:
There are few products in a product line that makes the company achieve social credibility from the market. One example that can be taken here is of Parle G biscuits. Parle company produces multiple products in biscuits and sweet confectionery segment. However, Parle G is considered to be low-cost healthy biscuits. Ending this product segment may question the going concern of the whole company itself. The company should continue the production even at minimal contribution.
Opportunity costs of the relived resources:
Dropping of a product may release some resources. However, it may not be immediately relieved. For example, it is practically difficult to immediately relieve the existing workforce and if did, compensation is to be paid. Moreover, how would be the relieved resources will be used by the businessman is also a point of consideration.
Market impact through such a decision:
How will the market react to this decision? What will be the possible assumptions will the market make on this decision? Market credibility is always important for a business. Discontinuation of the product segment may lead to a threat in the stakeholders of the company leading to a decrease in the market value of the company as a whole. One needs to take utmost care about the same.
Financial Consideration:
Apart from the above, one has to view it from a financial perspective. Sometimes, a product seems to be making losses as against reality. Discontinuing such a product would lead to a reduction in the profits of the business.
Yes, you heard it right, discontinuing a loss-making product line offerings can reduce the profits of the business. Let me explain to you the same through one of our cases.
Case:
The company was producing 3 products; A, B and C. As per the businessman, the products B and C were making losses and so he wanted to discontinue both B and C based on the following information. (Exhibit 1)
(Exhibit 1)
(Amount in Rs.)
| Particulars | A | B | C | Total |
| Sales | 70,000 | 30,000 | 35,000 | 1,35,000 |
| Less: Material Cost | (32,500) | (5,000) | (5,000) | (42,500) |
| Less: Labour Cost | (15,000) | (7,000) | (8,000) | (30,000) |
| Less: Manufacturing Cost | (8,000) | (16,000) | (18,000) | (42,000) |
| Less: Selling Cost | (7,500) | (6,000) | (8,000) | (21,500) |
| Net Profit / (Loss) | 7,000 | (4,000) | (4,000) | (1,000) |
Prima facie, the businessman is correct in his point. However, he is not totally correct. What we did is that we bifurcated total cost into fixed cost, variable cost, semi-fixed cost and semi-variable cost. And then we bifurcated semi-fixed cost and semi-variable cost into fixed and variable cost.
Through the above methodology, we arrived at the following working as specified in Exhibit 2.
(Exhibit 2)
(Amount in Rs.)
| Particulars | A | B | C | Total |
| Sales (A) | 70,000 | 30,000 | 35,000 | 1,35,000 |
| Less: Variable Cost | ||||
| Material Cost | (32,500) | (5,000) | (5,000) | (42,500) |
| Labour Cost | (10,000) | (5,000) | (8,000) | (23,000) |
| Manufacturing Cost | (7,000) | (4,000) | (17,000) | (28,000) |
| Selling Cost | (5,000) | (3,000) | (6,000) | (14,000) |
| Total Variable Cost (B) | (54,500) | (17,000) | (36,000) | (1,07,500) |
| Contribution (C ) = (A) – (B) | 15,500 | 13,000 | (1,000) | 27,500 |
| Total Contribution | 27,500 | |||
| Less: Fixed Cost | ||||
| Labour Cost | (7,000) | |||
| Manufacturing Cost | (14,000) | |||
| Selling Cost | (7,500) | |||
| Total Fixed Cost (D) | (28,500) | |||
| Net Profit (C ) – (D) | (1,000) | |||
What is Contribution: Contribution is net surplus generated by the product after deducting it’s all variable expenses from the sales of such a product.
Contribution = Sales – All Direct Variable Expenses
Here, we can observe that product B has a net positive contribution of Rs. 13,000, whereas product C has a net negative contribution of Rs. 1,000. Hence, discontinuing product C would be advisable however discontinuing B would increase the loss of business. Let me show you the after picture of both the alternatives.
Alternative 1: Discounting both the Products B & C
| Particulars | A |
| Sales (A) | 70,000 |
| Less: Variable Cost | |
| Material Cost | (32,500) |
| Labour Cost | (10,000) |
| Manufacturing Cost | (7,000) |
| Selling Cost | (5,000) |
| Total Variable Cost (B) | (54,500) |
| Contribution (C ) = (A) – (B) | 15,500 |
| Less: Fixed Cost | |
| Labour Cost | (7,000) |
| Manufacturing Cost | (14,000) |
| Selling Cost | (7,500) |
| Total Fixed Cost (D) | (28,500) |
| Net Profit/ (Loss) (C ) – (D) | (13,000) |
Alternative 2: Discounting only Product C
| Particulars | A | B | Total |
| Sales (A) | 70,000 | 30,000 | 1,00,000 |
| Less: Variable Cost | |||
| Material Cost | (32,500) | (5,000) | (37,500) |
| Labour Cost | (10,000) | (5,000) | (15,000) |
| Manufacturing Cost | (7,000) | (4,000) | (11,000) |
| Selling Cost | (5,000) | (3,000) | (8,000) |
| Total Variable Cost (B) | (54,500) | (17,000) | (71,500) |
| Contribution (C ) = (A) – (B) | 15,500 | 13,000 | 28,500 |
| Less: Fixed Cost | |||
| Labour Cost | (7,000) | ||
| Manufacturing Cost | (14,000) | ||
| Selling Cost | (7,500) | ||
| Total Fixed Cost (D) | (28,500) | ||
| Net Profit (C ) – (D) | 0 | ||
Hence we can see, by discounting product C only, we increase our profit by Rs 1000.
After witnessing the above, you may certainly accept the fact that the decisions which seem to be prima facie correct are not always actually. One needs to consult experts and consider all the aspects of decision making. Discontinuation if necessary, has to be at the right time with the right strategy in the right manner.