Common sense would tell you that if you have unprofitable products, removing them from your portfolio will increase the overall profitability of your business. In some cases, however, it’s acceptable, if not desirable, to sustain an unprofitable product indefinitely.
Here are four scenarios where a company can create value for itself and its customers despite selling a product at a loss.
Under many circumstances, selling one product at a loss may drive significant value for other products. The classic example of this is inkjet printers, which for a long time have been sold at or below cost to attract customers, who inevitably purchase high-margin ink cartridges from the manufacturer, driving significant value to the bottom line. This value would not exist without the loss leader in the portfolio, because it attracts the customer to other more profitable products.
With many new emerging technologies, a product may be offered at a loss initially to increase customer uptake. A current example is the tablet market, which has been dominated to this point by manufacturers creating products that consumers “don’t know they need (or want).” In such a market, a new technology might be offered at a loss to encourage trial and drive acceptance among consumers. This has been rumored to be the strategy of Amazon with many of its new e-readers as the firm tries to crack Apple’s dominance in the market with its iPad.
There may be ways to reverse the fortunes of an unprofitable product by reducing costs or streamlining overhead. Before eliminating a product from your portfolio, determine what specific costs are driving the value destruction. Are costs primarily fixed or can they be variablized? Does the infrastructure surrounding the product exceed what is required? Are there opportunities to streamline production? An unprofitable product can often serve as an indicator of operational inefficiencies that can impact the profitability of multiple products in the portfolio.
For some products, the cost structure is sound, but the revenues are still insufficient to achieve a profit. In this instance, it is important to evaluate the price of the product. Does the price indicate what the market will allow or is a higher price justified? This is largely the strategy behind many premium products, which have a higher cost structure but provide significantly more value to the customer, warranting a higher price.
Evaluating product profitability is a valuable tool for managing your product portfolio, but assessing a product from the portfolio view is also important in making the correct business decision. In every case, you need to develop the facts to understand why a product is unprofitable and the value it provides to the overall portfolio. You always need to prove why maintaining an unprofitable product in the short term will create value over the long term. Otherwise, it’s best to stop the losses.
Do you have unprofitable products in your portfolio? Send us your comments and questions at email@example.com.
Avondale associate Matt Cunningham contributed to this article.