Cost Volume Profit
Closing Product Line Decision
Should You Close a Product Line?
The obvious answer in determine whether you should keep operating or close a product line is whether that product line is making or losing money.
In that case:
If Product Line is Losing Money = Close Product Line
If Product Line is Making Money = Keep Open Product Line
However, we should also consider other quantitative factors. Complementary products can also be impacted by the closure of a product line. For example, consider the sale of Printers and Ink. If the Printer Product Line was losing money, should we close the Printer Product Line? An immediate answer would be yes, however, we would need to consider how the effect of the closure of the Printer Product Line will have on the sales of Ink. If losses from Ink were greater than losses from the Printer Product Line then it would not be in the business's best interest to close that product line. The business will also need to consider qualitative (non-monetary) factors as outlined in the below section.
What are the Qualitative Factors to Consider? (Non-Monetary Factors)
The business should consider the effect closing a product line will have on customer loyalty and customer satisfaction. Failure to sell a particular product line can reduce store traffic and sales of complementary goods.
The business should consider, before closing down any product line, what the potential increase in real estate could be used for. By real estate, we mean the additional production space or retail area that can be freed up as a result of the closed product line. If the additional space is not used, then this can be an additional expense. However, if the additional space could be rented out or used to promote the production or sales of existing product lines.
The closed product line could result in layoffs of workers. The business should consider its potential reputational risk if it cannot relocate those workers to different areas of the business.
Worked Example: Closing Product Line Decision
Mugs Galore is a manufacturer of novelty mugs. Management has asked for the review of the glass mug as profitability appears to be weakened in recent years.
The glass mug has sales of $250,000, direct materials of $180,000 and direct labour of $50,000. Total fixed costs for the entire business (not just the glass mug product line) is $500,000.
The business anticipates if it closes the glass mug product line, it can rent out the unused space to another factory for $25,000 per year. Based on purely quantitative analysis, should the product line be closed?
Step 1: Calculate the Current Contribution Margin of the Product Line
Contribution Margin = Sales - Variable Cost
Contribution Margin = $250,000 - $180,000 (Direct Materials) - $50,000 (Direct Labour) = $20,000
Step 2: Determine the Opportunity Cost from Closing the Product Line
Earnings = $25,000 per year
Step 3: Compare
Keep the Product Line Open: $20,000 per year
Close Product Line = $25,000 per year
The business should close the product line as this will produce an additional $5,000 per year in earnings.