Shuting down a profitable business to reduce costs

Question

Hi all,

In a cost reduction case, a suggestion to reduce costs was to stop manufacturing a specific product. The cost would be lowered by $6000/year, but this specific product segment is still profitable (profit of $1500/year). Saving $6,000/year in costs and suffering a maximum reduction of $1,500/year in profits is deemed to be a net gain of $4,500/year, and therefore a good option.

1. Can cost saving be considered as "profit" ?
2. When does it make sense to shut down a profitable product ? My first assumption is that is does when we know we could use the cost saving to develop a more profitable product.

Any insights on that?

Best

Marie-Eve

Answer 1

Hi,

I agree with Anonymous. Costs are not profits but contribute to them. Thus your answer must elaborate on the the difference of profits realised if the product persists or is terminated.

Reasons to shut down a profitable business line:-

1. Cannibalization. This does not need to be for a product in the same category eg. customers stop buying a perfume from a beauty firm because they do animal testing of their make up products

2. There is no competitive advantage and the firm's market share is/will erode quickly in this product segment. Here it may be better to realise the savings and invest the capital in a more profitable area eg. strengthen a dominant position, develop a new product etc

3. The product has a negative effect on the company's brand (intangible effect)

Answer 2

Hi, hope this might help.

Always remember that PROFIT = REVENUES - COSTS. Therefore, I wouldn't say that cost saving is considered a profit, but that: "IF THE REDUCTION IN COSTS IS GREATER THAN THE ONE IN REVENUES (considering this scenario in which we are shutting down a product line), THEREBY THE COMPANY WILL INCREASE ITS PROFITS".

Regarding the second question, another idea is shutting down a profitable product because it is cannibalizing others with higher profit margins.

Answer 3

1. Cost reductions can not be considered as profit increases as usually they entail revenue reductions as well. In your example, you would simply decrease your costs by 6K, but apparently also decrease your revenue by 7.5K, hence loose 1.5K profit.

2. It makes sense to shut down a profitable product when it cannibanilzes other profit sources or when it binds resources that you could use otherwise to increase profit with a different product.