Whether it’s a specific product or a new market, you should do your best to make it a success. But you should also know when you’re going after something that won’t materialize into much and should be discontinued. When you discontinue a product that’s failing, you create an opportunity to pursue more profitable ideas.
When to Discontinue a Product
I’ve built a number of software-as-a-service (SaaS) companies. The critical metric to measure success in most businesses, including a SaaS business, is customer loyalty or repeat customers. When these indicators aren’t moving in the right direction, it may be time to discontinue a product.
It doesn’t matter what type of business you run. As small business owners, we often fall in love with our own ideas. However, when you’re married to a product or idea that isn’t getting traction, you are holding back your growth.
It could be a product you developed or one that you resell. Be honest about the numbers and they will tell you the right thing to do.
Here are 3 signals we used to determine which product lines to sell off or discontinue and which markets to stop targeting.
Also read: 6 Tips to Improve Your Gross Margin
1. Slow Growth
If a product line is not growing 25%/year, take a hard look at the numbers. Usually, anything below 20% indicates that the product is costing you a lot of money to continue maintaining due to inherent customer attrition.
Sounds odd, right? Growing at 20% yet breaking even or losing money? Your exact breakpoint may vary, so let me explain how to arrive at the right number. Presuming a 10% churn rate per year (the percentage of customers that do not renew), a growth rate of 20% is really a net gain of 10%. Then, presuming a normal increase in internal costs such as staff salaries, cost of goods, and so on, that 10% may really be a net zero increase.
So, a 20% annual growth rate is barely a breakeven number for many businesses. In fact, the presumption of a 10% churn rate may be very high. Many businesses have churn rates in the 20-30% range, meaning that they have to gain 40-50% net new customers just to stay afloat. You should discontinue a product if you’re losing money on it.
2. Ratio of Revenue to Cost-to-Run
Another metric you can use to determine whether to keep or discontinue a product is the revenue vs. cost-to-run. An obvious decision to discontinue it would be if the ratio was below one, which indicates that you are spending more to maintain the product than the money you are generating from it.
However, if is lower than two, take a closer look. A 2x ratio implies a 50% margin, indicating a solid source of cash flow for your business. When that ratio falls below two, evaluate the opportunity costs. As a business leader, you need to see whether it would be more profitable to use your team/resources elsewhere and give up this product’s cash flow.
You may find that even at 25-30% margins, focusing on a higher profit margin product is a better bet for your business. The higher your margins (and the lower your churn), the more valuable your company is to a buyer. Discontinue low margin products so you can pursue more profitable ones.
3. Adoption Potential
To stay ahead of your competition, it is important to innovate. That can mean dreaming up new products or pursuing different markets with your existing products.
Don’t dive in without carefully evaluating your true potential. An idea might sound great on paper, or even inside the confines of your conference room, but you must test it out with potential buyers before you invest your hard-earned cash and valuable time.
One time, we had an idea for a great product to sell into our existing customer base. We did focus group testing and everyone loved it. Then, we discussed cost. What we had to charge to cover our internal costs alone was much higher than what clients would pay. So, we discontinued the product before we developed it.
It’s a good thing we tested market pricing first. We would have sunk $200,000 into developing a product nobody would buy. Discontinue a product idea if you know you won’t be able to make a profit on it. That’s bad for company morale as well as your bottom line.