Final answer:
A business segment with an operating loss that covers its variable costs contributes to fixed costs coverage, mitigating overall losses. Dropping such a segment decreases total operating income since the remaining segments must cover the now-unallocated fixed costs. This is especially relevant in the short run before a firm reaches the shutdown point where it's more economical to cease operations to avoid accruing further losses.
Step-by-step explanation:
When considering why a segment with an operating loss can cause a company to have a decrease in total operating income if the segment is dropped, it is vital to understand the concepts of fixed costs and variable costs. In the short run, a business segment with an operating loss may continue if its revenues cover its variable costs, even if not fully covering fixed costs. As a result, dropping the segment can still lead to a decrease in overall operating income due to the fixed costs that remain and must be covered by the rest of the company. In the long run, however, if the segment continues to operate without covering both variable and fixed costs, it can lead to sustained losses, justifying an exit from the market segment.
The shutdown point is a crucial consideration; it is the level of production where a firm may decide to stop operations to minimize losses. If a firm shuts down, it can avoid variable costs but still has to contend with fixed costs. Unless the costs of continuing production exceed the fixed costs, the company might opt to continue production in the short run to cover at least some of the fixed costs, even if it doesn't generate profit. Therefore, if a loss-making segment is dropped and its revenues were contributing to the coverage of fixed costs, total operating income could decrease, as the remaining segments now bear a greater burden of the fixed costs.