Relevant Costs for Decision Making: Keep or Drop aProduct Line

John Randazzo is the owner of a successful machine shop thatproduces automotive brake

components for national auto parts chains. These auto storessell "after-market" parts to replace

Those made by original equipment manufacturers such asGeneral Motors, Ford, and

Toyota. A great deal of volume diversity exists across theproducts manufactured by Randazzo's shop. For example, Randazzo mayproduce 80,000 brake components per year for vehicles such as theChevrolet Lumina, Ford Taurus, or Toyota Corolla; however, he mayproduce only 5,000 for the Corvette market. Selling prices varygreatly across the product line as a result of market supply anddemand.

The machine shop is highly automated and uses the most currentcomputer-numerically

controlled (CNC) equipment. By changing cutting toolsand.entering different measurements into the system, a variety ofproducts can be manufactured. Thus, machine costs are not traceableto a single product line, but are common to all products.Alternatively, many production costs are variable and can be tracedto individual products. For example, energy, material, and supplycosts differ among the products.

Randazzo's cost accountant recently completed a study thatassociated cost and revenue

Data with each product listed in the company's catalog. ExhibitA identifies sales volume,

Selling prices per unit, and variable costs for a sample of tenproducts representing the

mix manufactured by Randazzo. In addition to the variable costsidentified in Exhibit A,

the accountant estimated $600,000 of fixed costs would beassociated with the production

of these ten products.

The study produced startling results; two 0f the ten products inthe sample had variable

costs exceeding their selling prices. Upon analyzing the costreport, Randazzo marketing vice :President immediately defended thecurrent strategy of manufacturing a. full product line she arguedthat even though some products had costs in excess of their sellingprices, Randazzo should consider the big picture. Many of theircustomers were controllmg costs by reducing the number of vendorsfrom which they purchased merchandise. She argued that if Randazzono longer produced product G (Corvette brake components), retailchains would likely turn to Randazzo's competitors for otherproducts as well.

Randazzo knew that dropping products from the line wouldnecessitate lay-offs of some

Salaried and hourly employees. In the short run, lost productvolume could not be made up by increases in production of otherproducts. Over the years, he had worked hard to achieve a cultureof trust and cooperation within the company and the community.

Exhibit A

Product a b c d e f g h i j

Sales volume in Units ( X 1,000 50 80 10 20 70 25 5 12 11 15

$12 $15 $ 2 $ 10 $15 $10 $2 $ 5 5 8

$10 $11 $ 3 $ 8 $10 $ 8 $4 $ 4 5 6

A. What financial and nonfinancial considerations arerelevant to the management team s

decision to keep or drop a product line? .

B. Assume $70 000 of the $600,000 in fixed costs can besaved If products C and G are

, dropped. What is the total benefit to the company of droppingthe two products.

C. Do you agree with the marketing vice president's concernabout carrying a full product line?

D. As a consultant to Randazzos what would you recommend to

1. Ensure each product in the line of profitable or

2. Ensure the entire line is profitable