Reasons for Adding New Product
The product manager should not introduce a new product if an even better competing new product is available. Before taking a final decision, all the available opportunities and alternatives should be explored and examined and the best one chosen.
In other words, the opportunity costs of alternative uses of excess capacity must be estimated. The management should also appraise the impact of the new product on the existing products of the company. If the new product complements the product line, it will increase the sales of other products.
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In such a case the contribution to overheads and profits by introducing the new product will be greater than the direct contribution of the product itself. If, however, the product competes with existing items of the product line, the contribution estimates will be adjusted downward.
If the excess capacity is temporary, management must look at whether the product can be abandoned when demand for other products recovers. For it may well be preferable to accept temporary excess capacity than to create production bottlenecks when the excess disappears.
Management must examine whether it has the requisite know-how to produce and sell the product. The following are the reasons for adding new products to the existing product line of the firm:
Excess Capacity as a Reason for Expanding Product-line
The presence of excess production capacity is, perhaps, the most important single factor leading to product-line diversification. Broadly conceived, excess capacity is said to exist when it would cost the multiple-product firm less to make and sell the new product than it would cost a new company set up to produce only that product.
Excess capacity may occur for several reasons. It may be the result of an unduly over-optimistic estimated market for the firm’s products. In such a case, if the anticipated level of demand is not forthcoming, the firm develops excess capacity.
Excess capacity may be due to seasonal variations in demand also, the latter being a result of weather and customs, e.g. greeting cards, ice cream, etc. Companies faced with seasonal demand for their products would certainly find it advisable to add a to their product line in the off-season a new product to make up for the loss because of idle capacity.
OCM, manufacturers of carpets, have taken up the manufacture of synthetic fiber fabrics to avoid the disadvantage of seasonal sales of worsted woolen fabrics.
Overcapacity may further be caused by cyclical fluctuations in sales. Excess capacity may result from secular shifts in markets, tastes, buying habits, etc., leaving the firm with underutilized capacity and know-how. TISCO management was fully aware of the vulnerability of the steel industry to business cycles.
With this in view, the company promoted a large number of industries in and around Jamshedpur with a view to disposing of most of its steel at the minimum cost. In this process, a number of companies including India Tube Company, Tata Robins Fraser, TELCO, and Tinplate Co. were established.
Finally, the existence of an excess capacity may be the result of vertical integration. The reasons for vertical integration may, however, be many. The most obvious reason is to get a strategic market advantage. There may be an economic motive to integrate if fuller utilization of plant capacity or managerial, marketing, and research capacities leads to lower production costs.
Moreover, a purchasing firm can supply its own needs of raw materials and semi-finished components more economically through integration than by directly purchasing them from the market. Sometimes, a firm may have to pay lower prices if it purchases two or more products simultaneously. This is possible through vertical integration. Many companies do forward and backward integration to develop products in the value chain.
ONGC originally was an oil exploration company; subsequently, it went into the refinery and now they have entered into a retail distribution and marketing of petroleum products. Reliance Petroleum started its operation for the refinery business but went into both backward and forward integration by entering oil exploration and retail marketing.
To utilize unused capacity, some units in the public sector have also added their product lines. The Mining and Allied Machinery Corporation, manufacturers of coal-mining equipment, have taken up the manufacture of earth-moving equipment and accessories for the coal industry. Jessops, manufacturers of rail wagons, have added specialized cranes to their product line.
Profit as a Criterion of Optimum Product-line
Granted that there are sufficiently strong pressures on the firm to diversify its product line, the question is, what are the goals sought to be achieved by the firm in increasing its product line? In the long run, profit maximization may be the objective of the optimum product line. In the short run, however, income stability may be the more important goal.
Other short-run objectives are the continued existence of the firm, market share, volume growth, comfortable cash reserves, cordial labor relations, etc. Even these objectives, however, may merge with the long-run objective of profit maximization. Thus, profitability is the crucial test of adding to the product line.
The decision about adding a new product is not different from other managerial decisions. Incremental costs of adding the product are to be compared with incremental returns.
If the net return is more than the returns provided by alternative investment opportunities, a product may be added to the product line. Before deciding to add to the product line, a forecast of the demand for that product and the costs involved in the addition will have to be made.
Diversification as Response to Change
Many companies find it profitable to diversify and add to their product line in response to change. Changes may occur in the demand for their products, in the scope for further expansion, or in the overall economic, political, or social environment in which the company operates.
Hindustan Lever started in the 18th century as a sales organization and became a marketing company early in the 19th century. By 1930, it commenced manufacturing vanaspati and soaps.
Between the mid-50s and mid-60s, it diversified its activities into synthetic detergents, convenience foods, animal feeds, and dairy products. By the late sixties and early seventies, it was evident to the company that its future was more secure with further diversification into the ‘core sector’ of business.
Godrej and Boyce is another company, which has diversified its product portfolio over the years. Though the company started its business in lock and typewriter manufacturing, it discovered that the real business lies in office equipment and the fast-moving consumer goods industry; so it decided to enter into these businesses.
While electronic typewriters and computers were entering the market and manual typewriters were getting outdated, the company moved out of the business and entered into modern and attractive businesses.
Due to oil price hikes and the resultant cost compulsion, Daimler Benz which had built its reputation on limousines had to introduce a compact car for those who want ‘less comfortable interiors to exciting driving experience’. The objective was to lure customers away from rivals such as BMW, Audi, or Opel in Germany on desired consumer benefits.
Diversification as Response to Restrictive Government Regulations
To avoid the rigors of the various restrictive regulations, many multinational companies and those belonging to big houses have decided to diversify. Associated Cement Companies have diversified into high-technology areas like cast refractory.
BASF, the German multinational, has diversified to include leather chemicals in its product line because they were compatible with the technological and marketing expertise of the company.
Reliance Group has diversified into the retail business with an investment of 12000 crores, as the opportunity for growth lies in the emerging retail sector. ITC has added Marine Foods Division, Hotels Division, and General Exports Division to its traditional tobacco and cigarette operations. It has also started a successful paperboard business as a separate company.
The steadily increasing taxes and duties on major packaging raw materials and the preservation of much of the packaging industry for the smallscale sector, have led Metal Box to diversify into the manufacture of a variety of engineering products like off-set printing machinery and automobile bearings.
There are various other considerations for new product addition. The following is a list of other considerations for addition and change in product lines:
- A company may take advantage of its own strong points, e.g. sound distribution network. WIMCO’s diversification into the processed food industry is an example of this type. Crompton Greaves took up TVs because their household products, lights, and fans, had given them a lot of goodwill.
- A company may look for backward or forward integration and diversify into allied lines. OCM, a manufacturer of woolen carpets and worsted woolen fabrics went in for the production of synthetic fiber fabrics. This also reduced the company’s dependence on seasonal products.
- A company may go into totally unrelated products. This is because of incentives given by the government for the growth of a particular industry or region and also to provide a hedge against business cycles and recession.
Brooke Bond diversified rapidly into non-beverage lines. Companies marketing undergarments under the brand name ‘Amul’ have entered into the manufacturing of steel in Orissa due to the available opportunities and tax holidays offered by the state government.