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

Date01 January 2017
Published date01 January 2017
AuthorAlan Vercio
© 2017 Wiley Periodicals, Inc.
Published online in Wiley Online Library (
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
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.
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)

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT