To Stop or Not to Stop Making a Product?

The question is whether the business should stop making a product when it is unprofitable, or continue making the unprofitable product?

If a business makes more than one product (produces more than one good or provides more than one service), Contribution-Costing Technique shows managers which good or service is making the greatest or the lowest contribution towards paying Indirect Costs (Overheads).

By using Full-Costing Technique, we can determine whether a product makes a profit or loss, as we will know the Total Costs (TC), or Full Cost, of making that product after all Indirect Costs (Overheads) are apportioned proportionally.

While any individual product can surely make a loss, it can still make a positive contribution towards paying Indirect Costs (Overheads). This is because contribution only includes Direct Costs and omits Indirect Costs (Overheads).

Should a firm stop making unprofitable products? 

Ideally, the business wants to keep making products that both make positive contribution and are making a profit. However, this is not always the case.

When a product makes a loss, the business manager could decide to stop producing that product. The business may not want to continue producing a loss-making product forever as it will lower overall profits. 

However, unprofitable products can still be making positive contribution. In this case, it is not worth ending the production of such a product in the short-term. This is because Indirect Costs (Overheads) will still have to be paid. So, this unprofitable product still contributes somewhat towards paying fixed costs although there will be reduced contribution. Ending the production of a good making a positive contribution will also reduce the overall profits of the business.

When a business no longer has the fixed costs of the product then it should stop its production. 

An example when the business should not stop making an unprofitable product

The following example illustrates this principle of using marginal costing in deciding whether to stop making a product or not.

	PRODUCT A	PRODUCT B		TOTAL:
SALES REVENUE:	50,000		12,000	30,000
INDIRECT COSTS:	15,000		22,000	55,000
PROFIT:	–17,000		2,000 while Product B has made a profit of USD10,000 for Product A and USD25,000. So, even though the output produced and sold for Product A is zero, Indirect Costs (Overheads) of USD12,000 any longer, and it will lose all the sales revenue from selling Product A.  When the business produces Product B only, the amended data for each product and the company in total looks like this now:  PRODUCT A   PRODUCT B       TOTAL:    SALES REVENUE: 50,000 0 18,000    INDIRECT COSTS: 15,000 10,000 43,000 PROFIT: –17,000 15,000 to USD$7,000. Therefore, the accountant is right to continue the production of Product A. It is because now all of the Indirect Costs (Overheads) will need to be covered from the sales revenue of Product B only, as there is not Product A any longer to bring any revenue.  Jerry Grzegorzek I am the Founder and Editor-in-Chief of the SuperBusinessManager.com website. I am the EU citizen with approximately 20 years of experience in secondary and higher business education in both public and private sectors. Currently living with my wife and our two adorable children in China where I teach Business Management and Economics at K-12 international schools. Professionally, I am an experienced Lecturer and Researcher in Business Management and Economics, as well as IB Examiner for DP Business Management at International Baccalaureate (IB). Privately, I enjoy reading and collecting books on business management, personal finance and investing. You can contact me at jerrygrzegorzek@hotmail.com « Evaluation of Cost Centers and Profit Centers    |    Should the Business Accept an Unprofitable Order? » Comments are closed. Scroll to the top Exit mobile version