What it means
When a business launches something new, some of the customers who buy it would have bought an existing product instead. Those switched sales are not new revenue for the company as a whole, even though they show up clearly in the new product's own figures.
Erosion is sometimes called cannibalisation, and in capital budgeting it counts as a relevant incremental cost of the project. The correct question is never how much the new product will sell, but how much better off the whole company will be with it than without it.
Measuring erosion requires an estimate of what proportion of new sales are switched rather than genuinely additional. Marketing teams usually build this from customer research, pricing overlap and experience with previous launches, and the honest answer is often a range rather than a single figure.
There is an important counter-argument that boards need to hear. If a competitor is going to launch a similar product anyway, the sales will be lost regardless, so choosing not to cannibalise your own line simply hands the business to someone else.
Erosion also runs in the other direction as an enhancement effect. A new product can lift sales of complementary existing items, and a full analysis should capture that positive spillover alongside the negative one.
In practice
Real-world examples.
Example
A car maker launching an electric saloon accepts that roughly a third of buyers would otherwise have bought its own diesel model, and builds that switching into the business case before approving the tooling spend. Without that adjustment the project would have cleared the company's investment hurdle on paper while adding very little in practice.
Example
A publisher introducing a cheap digital subscription models how many print subscribers will downgrade, because print carries a much higher contribution per subscriber than digital does. Every switched subscriber therefore reduces total profit even though the digital product looks healthy on its own.
Example
A coffee chain opening a second site four streets from an existing one forecasts a 12% fall in the original shop's takings and treats that reduction as a cost of the new location. The regional manager still supports the opening, because a rival was actively looking at the same parade of shops.
Formula
Calculation
Erosion = Lost revenue on existing products x Contribution margin of those products
Incremental contribution = New product contribution - Erosion
A snack manufacturer plans a new high-protein bar.
Forecast revenue for the new bar: $5,000,000 a year, at a contribution margin of 35%.
Contribution from the new bar: $5,000,000 x 35% = $1,750,000.
Research suggests the existing cereal bar range will lose $1,200,000 of revenue to the new product, and that range earns a 40% contribution margin.
Erosion: $1,200,000 x 40% = $480,000.
Incremental contribution to the business: $1,750,000 - $480,000 = $1,270,000.
The project still looks worthwhile, but the genuine annual benefit is $1,270,000 rather than the $1,750,000 the brand team originally presented, a difference of $480,000 that would have flowed straight into an overstated net present value.Case study
Seen in the real world.
The following is an illustrative and fictional example. Ashgrove Tools, an invented supplier of garden equipment, sold entirely through independent dealers and proposed launching its own online store to reach customers directly.
The initial business case showed $3,000,000 of online revenue at a 50% contribution margin, worth $1,500,000, because selling direct removed the dealer discount. The finance team then estimated that dealers would lose $1,000,000 of sales to the website, and since dealer sales carried only a 30% contribution margin, erosion came to $300,000. The genuine incremental contribution was therefore $1,200,000.
The board approved the project anyway, but the illustrative point was that the erosion analysis reframed the whole debate. The argument shifted from whether the website would sell well to whether the dealer network would stay loyal once it saw the manufacturer competing with it directly. The finance team also added a second scenario in which unhappy dealers switched a further $500,000 of sales to a rival brand, which cut the incremental contribution to $1,050,000 and made the decision look much closer than the original paper had suggested.
Watch out
Common mistakes.
- Counting all of a new product's sales as incremental when a large share simply moves customers from one of your own products to another.
- Applying the new product's contribution margin to the eroded sales, when the correct margin is the one earned by the product losing the business.
- Ignoring erosion because it is hard to estimate, which is effectively assuming it is zero, the least likely answer of all.
Questions
People also ask.
Is erosion the same as cannibalisation?
Yes, the two words are used interchangeably in capital budgeting, though erosion is the more common term in formal appraisal.
Should erosion be counted if a competitor would take the sales anyway?
No, because those sales are lost in both scenarios, so they are not caused by the new project and are not incremental.
Can a new product have negative erosion?
In effect yes, when it lifts sales of complementary products, and that enhancement should be added to the project's incremental cash flows.
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