Relevant Costs in Eliminating a Product or Segment

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  • 0:03 Relevant Costs of Elimination
  • 1:16 Role of Incremental Analysis
  • 1:50 Fixed Cost Behavior
  • 2:28 Examples
  • 4:08 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Companies are constantly adapting, which means that they have to work to realize when it is time to look at ending products. In this lesson, we'll look at the relevant costs of eliminating a product or segment.

Relevant Costs of Elimination

Few businesses stay in business forever selling the same product or service. At some point, your company will have to consider whether or not it is the right time to eliminate a product or service from your offerings. This is not a decision to be taken lightly. Companies that stop selling popular goods not only lose out on profits, but also risk alienating their client base. On the other hand, many companies have failed because they didn't know when to stop offering a product or service that was simply too expensive to keep trying to profit from. In this lesson, we'll look at how to establish the relevant costs in order to make a decision on whether or not to eliminate a product. We'll also look at the role that incremental analysis can play in this decision.

Relevant costs refer to all of the costs of pursuing a product or service that would be altered if a change was made to that product or service. Let's say that you wanted to look at the relevant costs of keeping your procurement work in-house as opposed to outsourcing it. A relevant cost would be the salaries of your procurement staff. Meanwhile, the salaries of the manufacturing staff would not be a relevant cost, as they are unchanged by any action taken regarding procurement.

Role of Incremental Analysis

As you might imagine, there are a lot of different changes that are made when the decision to eliminate a product is considered. This is one of the reasons that incremental analysis is so important. Remember that incremental analysis allows us to examine only the changes that actually matter in a decision, no matter how small they may be. This is important, as such a decision is likely to have many smaller changes across the board. Many of these changes might slip through the cracks if we continued to only look at a situation from the perspective of keeping everything that would have otherwise been unchanged on the table.

Fixed Cost Behavior

Because changes to one area of business can affect other departments, we have two different likely outcomes when incremental analysis is used to look at what would happen if an area of practice was eliminated. First, there are those situations that do not see a change in fixed costs. If you were to get rid of the procurement department, you would still likely pay the executive management the same salary. This fixed cost remains the same no matter what. Meanwhile, you would have some fixed costs that would change. For example, if you got rid of the procurement department, you would probably no longer have to pay the fixed cost of the procurement department manager's salary.

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