Guidelines for Product Margin
Knowing when to cut your losses and abandon a product line is an important part of the job of a manager. It is hard to dump a product for which so much has been invested, but as a manager you have to realize that those are sunk costs which must be made. It is best to evaluate a project with what the future cash flows will be, and not from the perspective of what has been spent on the product. One of the key ways in identifying failing product lines is analyzing gross margin.
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Product Margin
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It all starts with how much money a business is making on a product. If your profits per sale of each product are 5 percent of sales before any of the other costs, you are most likely making a bad investment. Depending on what life stage the product is in, you want to at least be making enough on the product sales to cover the overhead costs related to operating the product line.
Cost Of Goods Sold
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Figuring out how much it cost to produce the product should be a simple task. It is easy to calculate the cost of materials involved and how much labor has been used to produce it. It also may be important to take note of carrying costs for the inventory, if there is any, to make sure you are taking all of the potential costs into consideration, not just the ones that are easy to calculate.
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Determining Overhead Costs
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If the company is a multinational with a number of businesses and product lines, determining the overhead costs for one product will be a challenge. One way this could be done is by first calculating the direct costs spent on the product, such as marketing and salaries of managers working on the product. Then, you can break down company overhead by departments and see how much of the total sales for the department the product generates. You can then take the percent of total product sales it generates as a percent of department overhead, to see approximately if the product is profitable or not.
Making A Decision
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Figuring out if you want to keep the product as part of your business or not, ultimately depends on future cash flows of the product and other opportunities. If the current product is generating solid returns, but there is another product on the horizon that has a good shot at generating spectacular returns, you may have to dump the product, to invest time and effort into the new one. There are other options, such as selling the current product line so it's not a total loss. Always be on the lookout for potential products that may be a better investment than the current products in the portfolio.
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References
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