Profiting from the declining product

W A L T E R J. TALLEY, JR.

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Profiting from the Declining Product

ore and more companies are finding

M the proper management of declining

products as productive a source for holding or increasing profits as the introduction of new products from the research laboratory. This increased awareness of the latent profits in declining products has been accelerated under the pressure of the current profit squeeze. This article is a chapter from Mr. Talley's yorth. coming book, The Protltable Product: Its Planning, Launching, and Management. The author is currently Director of Marketing with Southwestern Engineering Company in Los Angeles.

SPRING, 1964

For example, a soft-drink manufacturer noted that one product had been declining steadily in sales for several years despite advertising and marketing efforts that were equivalent to those maintained at the peak of its sales. Since marketing costs had been increasing steadily as a percentage of sales, even sizable marmfacturing economies had not changed a sharply declining profit pattern. Faced with a loss operation in the coming year on this product (and a general tightening of profits on other products ), the company studied the probable sales effects of cutting back the marketing effort. As a result of this analysis, the soft-drink company eliminated all advertising, shortened

WALTER J. TALLEY, JR.

the product line, and tightened marketing backup support in the form of sales and product management. Now, five years later, sales are still 50 per cent more than those at the time of the cutback on frills, and the product has become one of the most profitable in the company's line. The soft-drink manufacturer had considered a number of alternative actions before selecting the course that seemed to hold the greatest possibility of optimizing profits. He found that a different marketing strategy was required for the product in decline than was appropriate during the product's growth and maturity.

FOUR ALTERNATIVES

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Four basic courses are open to any management that chooses to deal with a declining product (or product line) : Discontinue the product Improve the product and/or marketing program in order to stop decline, thus plateauing sales Prune the product line in order to increase profitability Run-out the product (In this article, running-out the product means to cut back all support costs on a product to that minimum level which will optimize the product's profitability over the foreseeable limited life of the product). DISCONTINUE THE PRODUCT

For the expanding firm that wishes to devote its efforts to growing areas, this is often a wise course. Du Pont has followed this action in discontinuing their rayon line. Their action may have been dictated in part because the existence of rayon in their produet line hindered aggressive nylon merchandising. A more clear-cut example is in the silicon field where four companies-W. R. Grace, Foote, Eagle-Picher, and Du Pont-recently pulled out because of industry overcapacity and steadily falling prices. In most situations, discontinuation of the product is called for when incremental costs

exceed incremental revenues, although this point is most often passed before action is taken. PRODUCT/MARKET IMPROVEMENT

If the declining product is to be retained, the right kind of product improvement, change in the marketing program, or shift in distribution channels may give it the regeneration it needs to reach a sales plateau or even to reverse the decline. This is properly the first course of action management should consider with any declining product. However, efforts in this area all too often prove fruitless. A match company that, as we shall see, decided on run-out as a course of action, is a good example of such a failure. Attempts to revitalize the product and efforts to increase sales with lower prices and a bigger advertising campaign only resulted in a greater loss. But the simple fact that this alternative does not generally prove out should not prevent a company from trying to make innovations on a declining product. One food company with an old-line, premium-priced product, which had been declining for several years, decided to build a whole new concept of quality around this product. It developed a more attractive, modern package design, lowered the price just enough to make the product more competitive, and built an excellent advertising program. As a result, sales have increased 50 per cent, although profits are only slightly improved. But given a product that has not been neglected in terms of marketing ( as was the above food item), too few opportunities exist, as a rule, for the kind of action described above, particularly if the product is faced by strong marketing competition from competitors with broader lines. PRUNE PRODUCT LINE

Often it is possible to improve the profitability of a declining product line by pruning (selective elimination of unprofitable

BUSINESS HORIZONS

PROFITING FBOM THE DECLINING PRODUCT

products). One appliance manufacturer cut the number of items in his line from thirty to ten and found that his costs were not only reduced but, to his surprise, that sales increased. Apparently, his sales force could more easily sell a limited line. In the past, salesmen had become order takers, so involved in checking the hundreds of combinations of colors and models that they had often lost tile sale somewhere in the process. The more limited line allowed them to spend more time selling. Usually, pruning the product line brings with it an increase in profits and a decline in sales. Of course, such pruning must be based largely on controllable costs that can be eliminated by cutting items from the line. Cone Mills Corporation, a textiles manufacturer, represents a good example of the potential of selective pruning. Top executives, in commenting on 1962 performance, mentioned that profits for the year would have been 25 per cent higher and sales 25 per cent lower had some unprofitable products been eliminated. Thus, the company began last year to liquidate unprofitable products.

RuN-OuT

THE PRODUCT

Probably one of the most difficult acts for management is to face the fact that it has a product which is irreversibly in decline. Most companies hope that some miracle will dramatically reverse a downward pattern of several years. Usually, it is only after they have poured additional funds into new product development or improvement, new advertising campaigns, more intense sales efforts, special deals for distribution support, and other shots in the arm that they become aware of the difficulty (or impossibility) of expanding a declining product's market or of fighting a larger and stronger marketing competitor. At this point, it often becomes a question of pride versus profit. How much of the corporate profits should be drained trying to stop the decline on an unprofitable product simply because the

SPRING, 1964

product has played an important part in the history of the company? More and more companies are choosing the product run-out conrse for a number of reasons. First, "Fewer and fewer companies are able to make increasing contributions to their profits from the growth of established products sold in established markets. "1 This is the first of fonr competitive factors causing the second squeeze on profits as described by J. Roger Morrison and Richard F. Neusehel. The others are excess capacity, more sophisticated foreign competition, and resistance to further price increases. Under increasingly intense competition, the squeeze of increased costs of competitive marketing and product development and the higher per unit cost of low-capacity utilization can no longer be released by price increases. New approaches must be examined to take advantage of untapped profit potentials. And many companies are finding their greatest area of untapped potential lies in optimizing the profit on dedining products. Second, at a time when intense competition is shortening the product life cycle, it is becoming critically important for companies to maximize the profits of products in decline in order to generate investment funds for research and development for new products. Thus, obtaining the profit potential in many declining products is vital in many cases to the very existence of a company. Third, the run-out course allows a company to take fullest advantage of its competitive strengths on a particular product and to challenge competition where it is the weakest. Advertising can be limited either to the competitors' weak markets or to the company's strongest for greatest effect. Pricing can take advantage of any hardcore market the company may enjoy.

1 j. Roger Morrison and Richard F. Neuschel, "The Second Squeeze on Profits," Harvard Business Review (Jtdy-August, 1962), p. 53.

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WALTER J. TALLEY~JR.

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Fourth, in a period when most companies are battling head on with increased marketing efforts in every quarter, a company that reaps the profits of a good run-out can hit competition doubly hard in another area with a new product or new marketing approach-where it enjoys a stronger footing. Fifth, the run-out course is available to the small company as well as to the large company. It requires no fancy research laboratories or giant advertising budgets, but, rather, a careful analytical study to tailor a sharp-cutting marketing approach to the market strengths of the product. Sixth, the recognition by a company that its product is in the declining phase emphasizes today's shorter profit life cycle and makes management more conscious of the immediate need to develop new products and to optimize the growth and maturity performance on existing products. Thus, the very process of planning and executing a run-out tends to focus management's attention on other areas for growth before it is too late. RUN-OUT IN TWO COMPANIES

It is obvious that the second squeeze on profits makes it imperative for the marketing executive to take a fresh look at established

products in established markets. He must forget for the moment his preoccupation with volume rather than profits and resist the habit of assuming that profit improvemerit opportunities lie largely in manufacturing cost reductions. Instead, he must endeavor to make more profit selling what he has. Several companies in a number of industries have recently produced dramatic profit improvements by taking a hard-nosed, profit-oriented approach to their marketing activities. As examples, we can look at the experiences of two manufacturers, one in the match industry and one in the auto accessories industry. CASE A--MATCH COMPANY

A manufacturer of a number of general product lines for supermarkets found itself with a line of farmer (or kitchen) matches, which had been declining steadily in sales for several years. To arrest the decline, a revitalized marketing program was launched, which included redesigning the match box, instituting a sizable national advertising program, and lowering prices. The results were catastrophic; the decline in dollar sales continued and the only figures that mounted were the red ones on the profitand-loss statement. A subsequent detailed evaluation of the unique market demar~ds for the product indicated a run-out action program, which has turned this product into the most profitable in the company's line. CASE B--AUTO ACCESSORIESMANUFACTUBER An essentially one-product company in a mature segment of the auto accessories field found sales of its product declining 7 per cent annually for the last five years. The company was faced with three or four major competitors, all much larger and all with significantly broader product lines. In spite of a price level generally lower than that of its competitors, the product enjoyed only a 4 per cent share of the national market with some regional strengths up to 12 per

BUSINESS HORIZONS

PROFITING F R O M TI~IE DECLINING PRODUCT

cent. The company still retained a hard core of long-established users in certain key markets. Unfortunately, the company had little or no research and development capability, and most product innovations had been made by competitors. A detailed analysis resulted in a program that substantially increased profits and reduced the rate of decline in key markets. As a result, the company has been able to make substantial investments in new product development and acquisition efforts that promise to place the company in faster growing and more profitable fields. THE PROCESS What did these companies do that so radically altered the profit results realized from their weakening: product? How did they go about it? Generally the process was a painful one. It took a realistic a~citude on the part of top management, combined with a thorough look at the market, competitive strengths, brand franchise, advertising, manufacturing costs, and distribution. In addition, it required forgetting tradition and shaping an action program to tap the latent profits of their products.

Determining Market Needs, Trends In the case of the match company, a study of the market demand indicated a hard-core declining market. The unsuccessful attempt to expand the market through lower prices and national advertising was additional proof of this fact. Such a market called for a run-out program in order to maximiza product profitability. On the other hand, the auto accessory manufacturer's product was in a mature but gradually expanding market, so the study of the market in this case did not determine the marketing alternative. Sharply declining market demand for a product caused by other than short-run economic forces will, coupled with declining product sales, indicate a run-out course. However, a mature total market, growing only gradually, does not necessarily indicate a run-out course of action.

S P R I N G , 1964

Identifying Strength of Competition Declining sales in the face of a slowly increasing total demand are reflected, of course, in a declining share of market. In most cases where the company has not sharply changed its marketing effort, such a decline indicates the need for a strong competitive marketing effort. Typically, competition en~oys a substantial advantage in breadth of line, selling effort, or brand franchise. A run-out pattern is indicated here, either when the company cannot afford to match competition or when the potential return on investment from matching competition (and thus only holding or gaining slightly in share of market) is unattractive. The kitchen match company had enjoyed a fairly constant share of market versus competition. Here the key to a profitable run-out lay in holding costs to a minimum, particularly since competition was weak. On the other hand, in the auto accessories case it was the marketing strength of competition that finally weighed the balance in the direction of a substantially tightened marketing operation. Determining Strength of Brand Franchise The next question that should be considered is: What is the specific nature of the customer group, that is currently buying the declining product? A loyal group that is deeply convinced of the product's quality and may be even paying a premium for the product is an indicator of a high run-out profit potential. If the brand franchise is strong enough (a characteristic generally, but not always, related to a past pattern of good advertising), a price increase may even be indicated. On the other hand, a product where price is the major factor in the buying decision represents a less attractive run-out potential, and a price increase probably should be eliminated from consideration. The kitchen match line enjoyed a relatively inelastic market (that is, total dollar sales declined with price decreases and increased with price increases). The automobile accessories firm, on the o.ther hand, had

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WALTE~ J. TALLEY, JR.

much less price latitude. It had to be in the same bracket with its much larger competitors in order to survive.

89.

E~aluating Effect of Advertising In the case of the match company, a decrease in prices and an increase in advertising had no effect on the product's decline, making it clear that advertising was not productive of sales. However, in the accessories case careful study indicated that the focusing of advertising in selected concentrated markets would pay for itself by arresting sales declines. Thus, in one case advertising could be eliminated, but, in the other, it had to be directed at individual markets. In general, a run-out course is indicated where the interrelationship of advertising with sales is difficult to determine, and where the elimination of advertising may not affect the product's sales for a year or two. In these cases, a run-out is particularly attractive because advertising expenditures themselves often amount to several times the profit on the declining product. In some cases, a selected local or regional advertising program may be indicated at reduced levels instead of a national advertising campaign. This course is often followed where a product enjoys a strong local position; thus local advertising will pay back by stemming the sales decline. Analysis of Manufacturing Cost Manufacturing costs must be analyzed in terms of their fixed and variable components in order to determine how they are affected by volume declines. In this type of analysis, efforts must be undertaken to determine incremental costs, so that "sunk costs," such as depreciation, are not considered in the decision to close the plant. Raw material costs that represent a high portion of the total manufacturing costs indicate that the run-out procedure may be quite profitable. The good run-out prospect generally breaks even at 40 to 50 per cent, or less, of current physical volume (see Figure 1). Of course, the true indicator is the level of decline

FIGURE 1

Break-Even Guide for Good Run-Out Prospect

SALES

LEVEL OF OPERATION

GROSS PROFIT

5 u_ 5 (D o

3 BREAK-EVEN ( 4 0 - 5 0 % of 2

current level )

VARIABLE COSTS

FIXED COSTS

25

50

75

t00

% of Capocity

physical volume can reach before breaking even with incremental marketing and manufacturing costs. The ability to raise price will, of course, have a direct downward effect on manufacturing and distribution costs as a percentage of sales. In both the match and auto accessories cases, the products were found to reach a break-even point at about 25 per cent of current volume-an indication of excellent run-out potential.

Appraising Distribution Requirements It is important to determine what will be required to maintain distribution in order to learn the extent of action that can be taken in such areas as price, selling effort, and advertising. The ideal, of course, is a dis,tribution system, that reacts to consumer patterns and allows a variety of brands BUSINESS HORIZONS

P R O F I T I N G FIRO1VI T H E DECLI NI NG PRODUCT

rather than a system that limits stock to one or two brands and requires backup support. The supermarket is a good example of the kind of distribution system that allows multibrands and, to a certain extent, allows the "delisting" decision to rest on consumer buying patterns rather than on the extent of advertising or store effort. (Delisting is a term used in the supermarket field for discontinuing a certain brand. ) It was determined in both the match and auto accessories cases that although distribution would, of course, become more limited as volume declined, the products would continue to be available until sales levels reached a break-even situation from a manufacturing standpoint; at that time, the products would be taken off the market completely.

rate of decline would increase to double the current rate under the third alternative. After working out detailed models for each alternative, the third-eliminating all advertising and promotion-was clearly shown to provide the optimum profit contribution. In actual practice, however, the rate of decline, rather than doubling, has shown no significant change and thus profits have proved much better than estimates had indicated. As has already been mentioned, the identification of an inelastic pricevolume relationship for the match eompany led to a profitable price increase. In the case of the auto accessories manufacturer, four alternative advertising and marketing strategies were considered: Make no change Conduct a "holding" operation Eliminate all advertising and tighten other marketing effort.

CHOICES WITHIN RUN-OUT

Conclusions reached at each of the preceding steps must be considered and weighted in selecting the optimum course of action. In general, at least three basle alternatives will be open to a company having a product that fits the previous criteria: Continue the current pattern (not an alternative where the companies wish to remain profitable) Concentrate selling and advertising efforts in the stronger markets for the product Eliminate completely o.r substantially tighten total marketing efforts. The pricing out of these and other meaningful and practical alternatives is at best a difficult and risky process. In tile case of the match company, each of the three general alternatives described above were weighed by the study team and management as to the probable effect on the rate of decline. The following assumptions were felt to be realistic: current rate of decline would continue under the first alternative; current rate of decline would continue in metropolitan markets, but would increase to double the current rate in other markets under the second alternative; and

SPRING, 1964

The last alternative was ruled out by management because of the unlikelihood of reversing the downward sales trend. Three factors were considered significant here: large eompetitors would "outspend" any such efforts; the existing pro.duet lacked uniqueness on which to. base effective advertising and promotion claims; and the company lacked sufficient financial resources to provide the advertising support needed for any sustained growth program. Next, the first alternative was ruled out because this action would have put an end to the one-product company's business in light of the current rate of decline. Similarly, the third alternative was ruled out despite its higher short-term profit generation because the estimated doubling of the rate of decline from such a course would soon bring operations to a close. Thus, the second alternative, conducting a holding operation, was selected as the best means of improving profits, utilizing resourees, and gaining time to broaden the product base. The specific program involved eutting the advertising budget by 50 per eent, concentrating selling effort in the stronger regional markets, and investing

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WALTER J. TALLEY, JR.

additional profits in a program for new product development and acquisitions. In this ease, it was determined that the company was pricing its products 25 per cent lower than its competition in a market where a truly inelastic price-volume situation existed. Accordingly, price levels were brought into line with competition, and dollar-sales volume increased by 25 per cent and profit by 50 per cent.

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WHATis so new about running-out a product? Aren't we, in effect, talking about "milking" a product? The answers may be both yes and no. A study of the approaches of various companies to managing declining products indicates that many unknowingly milk products through selling and advertising efforts insufficient to combat competitors effectively but too great to allow profits. Other companies, afraid to go more than halfway, often receive only a proportion of the total profit potential for their declining product. The approach described in this article differs in that it represents a systematie study of market demands, competition, brand franchise, the effect of advertising on buying, manufacturing costs and dis-

tribution, resulting in a final crystallization of the best available estimates in terms of a series of alternatives. A course of action may then be shaped for the product based on the alternative that best optimizes profits. Probably the most difficult part of this process is gaining management recognition of the inevitable nature of a product's decline. Too many companies live with traditional products in a never-never land with the constant hope that declining sales will plateau. But, all too often, the economics of the product do not justify the marketing effort necessary to arrest decline; thus the run-out course becomes necessary. Management recognition of this course often has a positive influence by forcing them to set up research and development or acquisition programs in order to maintain the total companies' sales. Often the profits possible from optimizing declining products are sufficient to finance an acquisition or support a new product's research and development program. Marketing actions geared to optimizing profits OH often-neglected declining products may provide top management with a partial solution-at least in the short t e r m to the second squeeze on profits.

T H E TWO bearded gentlemen who grace the package of Smith Brothers Cough Drops have become a legend-affectionately known to generations as "Trade" and "Mark." Not so well known, however, is the fact that the Smith Brothers actually existed, although their names were William (Trade) and Andrew (Mark). • . . When a journeyman stopped at Smith's Dining Saloon one day and gave James the formula for a palatable and effective cough candy, James foresaw possibilities for such a product in the cold, windswept Hudson Valley and immediately mixed up a batch on his kitchen stove. The drops were an instant success and demand for the "cough candy" grew fast up and down the river. -Hannah Campbell W H Y DID T H E Y N A M E I T . . .

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BUSINESS HORIZONS