Marginal Contribution OPI

One-Point Insights [OPI] are the quickest way to learn and understand one key management topic at a time. A brief and simple analysis of Marginal Contribution that explains what it is, how to calculate it, and how to analyze and apply Marginal Contribution to make Product Portfolio decisions.

How does a company make profits?

A company makes a unit profit by selling products at a price that is higher than the cost of producing or buying the product (finished goods).

Having big profit margins for the products you sell is an ideal situation; however, there is always tough competition for similar products if your product does not have a unique and strong Value Proposition, much of the demand is going to be driven by price.

If this is the case, higher prices, and higher margins may mean lower unit sales [and less profits].

Lower prices and lower profit margins may mean higher unit sales [and more profits].

To sell more units you may need to lower your price and profit margins, or not, and live with lower unit sales. So, what is best for your company? An in-depth analysis using Price Models OPI and BGC Matrix OPI will guide you in the right direction.

IPrioritize and focus on the top money makers based on Accumulated Profits.

(See the XYZ Model OPI)

Decision Example: Here is a situation you may face in a manufacturing company ▼

Making Profit-Driven decisions

You have two products, and you find yourself having to decide which of two products will you manufacture; you must select one of them because you have enough raw material [both products use this material] to manufacture only one of the products and not the other.

Based on this information which product would you decide to manufacture?

Product 2 is the obvious choice, it has a strong 60% profit margin, almost three times as much as product 1 so, we could make more profit with product 2.

However, there is an important piece of information we are missing in this table; the number of Units Sold. We realize that Product 1 sells 120,000 units per year and Product 2 sells 15,000 units per year.

Let’s analyze our selection again:

1. Product 1 sells 120,000 units making $240,000 dollars in profit for your company (calculation is 120,000 (Units) x $2.00 (Unit Profit) = $240,000 dollars of Marginal Contribution.

2. Product 2 sells 15,000 units making $90,000 dollars in profit for your company (calculation is 15,000 (Units) x $6.00 (Unit Profit) = $90,000 dollars of Marginal Contribution.

Now that our second analysis includes volume – Units Sold – we discover that it is not wise to make the decision based solely on Unit Margin, you need to use Marginal Contribution [which is an Accumulation of Unit Profits] before deciding.

In this case, the best decision is to make Product 1 even though it has a much lower Profit Margin: 22%. Why? Because it makes $150,000 more dollars per year than product 2.

Marginal Contribution is the amount of profit you make through UNITS SOLD and UNIT PROFIT.

I Lower Prices and lower Profit Margins can lead to higher UNIT sales and more Marginal Contribution.

IUnits Sold multiplied by Unit Profit = Marginal Contribution (MC)

Driven by Volume, not by Margin.

Maybe the Price for product 1 should be higher…that way we can increase the Profit Margin to match the 60% margin of Product 2…would this be a good decision?

Think about this; if you lower your product’s selling Price and cannot reduce the Unit Cost (maintaining quality), your product’s Unit Profit decreases to compete in a market where the price is an important volume driver because of competitors with similar products and prices.

In this scenario the only way you can maintain the company’s Marginal Contribution is by increasing unit sales and the lower price may help you to increase volume.

Unit Margin vs Unit Profit

Unit Margin is expressed as a percentage of Unit Profit divided by Unit Price. It is used to give an idea of a product’s profitability regardless of the Units Sold.

Unit Profit is expressed as a dollar amount resulting from subtracting the product’s Cost from its Price. It is used in combination with Units Sold to calculate the amount of money that the product is generating every time the company sells one unit.

The diagram below illustrates the calculation of Unit Margin, Unit Profit, and Marginal Contribution (MC). Calculating the MC for each one of your products will aid you in prioritizing and making the right Product Portfolio decisions.

I Marginal Contribution is built by the accumulation of Unit Profit, ONE UNIT SOLD at a TIME.

The Implications of Unit Profit

As with most things, there is the probability of positive or negative consequences. If your inventory management is superb, your Supply Chain will provide all the Sales Units you need, and no Profit will be lost.

On the other hand, if inventory management in your company is weak you will have lackluster performance and risk suffering the following consequences:

· Lose the Unit Profit from LOST SALES; that is for every unit you do not ship to customers.

· Increase the RISK of loss of future profit due to loss of goodwill from your customers.

· Delay in reaching your company’s Break-Even Point.

· Upset the morale of your Sales Force.

Explore, learn, and understand how to avoid these situations by reading the following OPIs from Celeran Enterprise Genetics, Inc. Find them here: https://celeraneg.com

1. Product Portfolio XYZ Analysis OPL

2. Reducing Supply Chain Risk OPI

3. Break-Even Point OPI

4. Delight Your Customers OPI [Measuring Lost Sales]

5. Price Models OPI