Contribution Margin and Fixed Cost per Unit: When to Use and When Not to Use These Analytical Tools

• DOI: http://doi.org/10.1002/jcaf.22244
• Date: 01 January 2017
• Published date: 01 January 2017
• Author: Alan Vercio

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© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22244

Contribution Margin and Fixed Cost

perUnit: When to Use and When Not

toUse These Analytical Tools

Alan Vercio

INTRODUCTION

This article reviews the

basic principles of contribution

margin (CM) and fixed cost per

unit (FCPU), provides alterna-

tive principles, and points out

when these analytical tools

should and should not be used.

PART I: CONTRIBUTION

MARGIN (CM)

The basic principle of CM

taught in the classroom can be

summarized as follows:

If price is greater than vari-

able cost plus avoidable fixed

costs, profit will be greater with

the product than without the

product. Accordingly, the prod-

uct or whatever is being evalu-

ated, such as a product line,

store, or a division, should not

be discontinued. CM is defined

as price minus variable costs.

For example,

… In this case the

fixed costs that can be

avoided by dropping

the housewares product

line ($15,000) are less

than the contribution

margin that will be lost

($20,000). Therefore,

based on the data given,

the housewares line

should not be discon-

tinued unless a more

profitable use can be

found for the floor and

counter space that it is

occupying. (Garrison,

Noreen, & Brewer, 2014)

Peter Drucker offers an

alternative view:

The first step in planning

is to ask of any activity,

any product, any process

or market, “If we are

not committed to this

today, would we go into

it?” If the answer is no,

one says, “How can we

get out—fast?”

Unless these ques-

tions are being asked

seriously and system-

atically, and unless

managements are willing

to act on the answers

to them, energy will be

used upindefending

yesterday. No one will

have the time, resources,

or will to work on

exploiting today, let

alone to work on

making tomorrow.

Systematic sloughing

off of yesterday is a plan

by itself—and adequate

in many businesses. It

will force thinking and

action. It will make

available people and

money for new things.

Defining the pur-

pose and mission of

the business is difficult,

painful, and risky. But

it alone enables a busi-

ness to set objectives,

to develop strategies,

to concentrate its

resources, and to go to

work. It alone enables

a business to be man-

aged for performance.

(Drucker, 1974)