Q: I am thinking of adding a new product line. What are some things I should consider to determine if the new line is worthy of launching?
A: When adding a new product line, there are numerous considerations. We will look at what goes into determining the potential profitability of the new product. This is important to do at the outset, as a gauge of profitability will set the stage for moving forward with the next steps of a possible product launch.
First, you should know how many items must be sold to make a profit. This is sometimes known as the break-even point. Take a look at what you think will be the costs specific to this product line. Will you have to hire a new administrative or sales person? Will you have to pay for additional legal or insurance costs? Will you have to buy any raw materials? Or will you have to hire new employees to assemble it?
Next, put these costs into two categories — fixed and variable. For the fixed category, include those expenses that will not change over the next planning cycle (insurance, legal, administrative, etc.). We will call this amount “F” for fixed costs.
In the variable category, put those that you know will change as you increase production or at least are directly related to the hands-on creation of the product (materials, direct labor of production, etc.). Take this second sum of costs and divide by your planned level of production. This will give you your variable cost per unit. We will call this amount “V” for variable costs.
Let “P” represent the planned sale price for the product. Your break-even point, or the necessary minimum quantity “Q” needed to be sold before you start making a profit, would be equal to the following:
Q = F/(P - V)
This is the bare minimum number of units you will have to sell in the next planning cycle before you cover your costs.
Now compare this amount with a benchmark that you think represents potential customers. If your customer base is smaller than Q, do not pursue this product line. If you think your base is larger than this, then it would be worthy of further market research.
Vang is a finance professor at the University of St. Thomas Opus College of Business.