Question

Looking at Apple Corp. as the manufacturing company for computers and smartphones, explain how you would determine the company's contribution margin (CM) and contribution margin percent (CMP). In your initial post include the following:

• Identify which specific variables should be included in the calculation.
• Illustrate your explanation by calculating the contribution margin and contribution margin percent using hypothetical values.
• Explain what your calculated results tell you about the company’s sales and cost structure.

Answer 1

The icontribution imargin ican ibe istated ion ia igross ior iper-unit ibasis. iIt irepresents ithe iincremental imoney igenerated ifor ieach iproduct/unit isold iafter ideducting ithe ivariable iportion iof ithe ifirm's icosts.

The icontribution imargin iis icomputed ias ithe iselling iprice iper iunit, iminus ithe ivariable icost iper iunit. iAlso iknown ias idollar icontribution iper iunit, ithe imeasure iindicates ihow ia iparticular iproduct icontributes ito ithe ioverall iprofit iof ithe icompany. iIt iprovides ione iway ito ishow ithe iprofit ipotential iof ia iparticular iproduct ioffered iby ia icompany iand ishows ithe iportion iof isales ithat ihelps ito icover ithe icompany's ifixed icosts. iAny iremaining irevenue ileft iafter icovering ifixed icosts iis ithe iprofit igenerated.

Contribution iMargin i= iSales iRevenue i− iVariable iCosts

Contribution iMargin iRatio i= iSales iRevenue i÷ iSales iRevenue i− iVariable iCosts

The icontribution imargin iis ithe ifoundation ifor ibreak-even ianalysis iused iin ithe ioverall icost iand isales iprice iplanning ifor iproducts. iThe icontribution imargin ihelps ito iseparate iout ithe ifixed icost iand iprofit icomponents icoming ifrom iproduct isales iand ican ibe iused ito idetermine ithe iselling iprice irange iof ia iproduct, ithe iprofit ilevels ithat ican ibe iexpected ifrom ithe isales, iand istructure isales icommissions ipaid ito isales iteam imembers, idistributors ior icommission iagents

i i i i i i i i iThe icontribution imargin ican ihelp icompany imanagement iselect ifrom iamong iseveral ipossible iproducts ithat icompete ito iuse ithe isame iset iof imanufacturing iresources. iSay ithat ia icompany ihas ia ipen-manufacturing imachine ithat iis icapable iof iproducing iboth iink ipens iand iball-point ipens, iand imanagement imust imake ia ichoice ito iproduce ionly ione iof ithem.

If ithe icontribution imargin ifor ian iink ipen iis ihigher ithan ithat iof ia iball ipen, ithe iformer iwill ibe igiven iproduction ipreference iowing ito iits ihigher iprofitability ipotential. iSuch idecision-making iis icommon ito icompanies ithat imanufacture ia idiversified iportfolio iof iproducts, iand imanagement imust iallocate iavailable iresources iin ithe imost iefficient imanner ito iproducts iwith ithe ihighest iprofit ipotential.

i i i i i i i i i i i i i i iBefore iexamining icontribution imargins, ilet’s ireview isome ikey iconcepts: ifixed icosts, irelevant irange, ivariable icosts, iand icontribution imargin. iFixed icosts iare ithose icosts ithat iwill inot ichange iwithin ia igiven irange iof iproduction. iFor iexample, iin ithe icurrent icase, ithe ifixed icosts iwill ibe ithe istudent isales ifee iof i$100. iNo imatter ihow imany ishirts ithe iclub iproduces iwithin ithe irelevant irange, ithe ifee iwill ibe ilocked iin iat i$100. iThe irelevant irange iis ithe ianticipated iproduction iactivity ilevel. iFixed icosts iremain iconstant iwithin ia irelevant irange. iIf iproduction ilevels iexceed iexpectations, ithen iadditional ifixed icosts iwill ibe irequired.

For ie.g., iassume ithat ithe istudents iare igoing ito ilease ivans ifrom itheir iuniversity’s imotor ipool ito idrive ito itheir iconference. iA iuniversity ivan iwill ihold ieight ipassengers, iat ia icost iof i$200 iper ivan. iIf ithey isend ione ito ieight iparticipants, ithe ifixed icost ifor ithe ivan iwould ibe i$200. iIf ithey isend inine ito isixteen istudents, ithe ifixed icost iwould ibe i$400 ibecause ithey iwill ineed itwo ivans. iWe iwould iconsider ithe irelevant irange ito ibe ibetween ione iand ieight ipassengers, iand ithe ifixed icost iin ithis irange iwould ibe i$200. iIf ithey iexceed ithe iinitial irelevant irange, ithe ifixed icosts iwould iincrease ito i$400 ifor inine ito isixteen ipassengers.

Variable icosts iare ithose icosts ithat ivary iper iunit iof iproduction. iDirect imaterials iare ioften itypical ivariable icosts, ibecause iyou inormally iuse imore idirect imaterials iwhen iyou iproduce imore iitems. iIn iour iexample, iif ithe istudents isold i100 ishirts, iassuming ian iindividual ivariable icost iper ishirt iof i$10, ithe itotal ivariable icosts iwould ibe i$1,000 i(100 i× i$10). iIf ithey isold i250 ishirts, iagain iassuming ian iindividual ivariable icost iper ishirt iof i$10, ithen ithe itotal ivariable icosts iwould i$2,500 i(250 i× i$10).

Contribution imargin iis ithe iamount iby iwhich ia iproduct’s iselling iprice iexceeds iits itotal ivariable icost iper iunit. iThis idifference ibetween ithe isales iprice iand ithe iper iunit ivariable icost iis icalled ithe icontribution imargin ibecause iit iis ithe iper iunit icontribution itoward icovering ithe ifixed icosts.

i i i i i i i i i i i i i i i iSay ia imachine ifor imanufacturing iink ipens icomes iat ia icost iof i$10,000. iManufacturing ione iink ipen irequires i$0.2 iworth iof iraw imaterials ilike iplastic, iink iand inib, ianother i$0.1 igoes itowards ithe ielectricity icharges ifor irunning ithe imachine ito iproduce ione iink ipen, iand i$0.3 iis ithe ilabor icharge ito imanufacture ione iink ipen.

These ithree icomponents iconstitute ithe ivariable icost iper iunit. iThe itotal ivariable icost iof imanufacturing ian iink ipen icomes ito i($0.2 i+ i$0.1 i+ i$0.3) i= i$0.6 iper iunit. iIf ia itotal iof i100 iink ipens iare imanufactures, ithe itotal ivariable icost iwill icome ito i($0.6 i* i100 iunits) i= i$60, iwhile imanufacturing i10,000 iink ipens iwill ilead ito ia itotal ivariable icost iof i($0.6 i* i10,000 iunits) i= i$6,000. iSuch itotal ivariable icost iincreases iin idirect iproportion ito ithe inumber iof iunits iof ithe iproduct igetting imanufactured.

However, ithe iink ipen iproduction iwill ibe iimpossible iwithout ithe imanufacturing imachine iwhich icomes iat ia ifixed icost iof i$10,000. iThis icost iof imachine irepresents ia ifixed icost i(and inot ia ivariable icost) ias iits icharges ido inot iincrease ibased ion ithe iunits iproduced. iSuch ifixed icosts iare inot iconsidered iin ithe icontribution imargin icalculations.

If ia itotal iof i10,000 iink ipens iare imanufactured iusing ithe imachine iat ia ivariable icost iof i$6,000 iand iat ia ifixed icost iof i$10,000, ithe itotal imanufacturing icost icomes ito i$16,000. iThe iper-unit icost iwill ithen ibe icomputed ias i$16,000/10,000 i= i$1.6 iper iunit. iIf ieach iink ipen iis isold iat ia iprice iof i$2 iper iunit, ithe iprofit iper iunit icomes ito i

​                i i

(SC−Total iCosts)=($2.0−$1.6)=$0.4 iper iUnit

Where:

SC i= iSales iprice

However, icontribution imargin idoes inot iaccount ifor ifixed icost icomponents iand iconsiders ionly ithe ivariable icost icomponents. iThe iincremental iprofit iearned ifor ieach iunit isold ias irepresented iby icontribution imargin iwill ibe:

(Sale iPrice−TVC)= i($2.0−$0.6) i=$1.4 iper iUnit

Where:

TVC= iTotal ivariable icosts

A ikey icharacteristic iof ithe icontribution imargin iis ithat iit iremains ifixed ion ia iper iunit ibasis iirrespective iof ithe inumber iof iunits imanufactured ior isold. iOn ithe iother ihand, ithe inet iprofit iper iunit imay iincrease/decrease inon-linearly iwith ithe inumber iof iunits isold ias iit iincludes ithe ifixed icosts.

In ithe iabove iexample, iif ithe itotal inumber iof iink ipens imanufactured iand isold idoubles ito i20,000, ithe itotal icost i(fixed i+ ivariable) iwill ibe i($10,000/20,000 i+ i0.6) i= i$1.1 iper iunit. iThe iprofit iper iunit iwill icome ito:

​ i(SC−Total iCosts)= i($2.0−$1.1) i=$0.9 iper iUnit   

Essentially, idoubling ithe inumber iof iunits isold ifrom i10,000 ito i20,000 i(two itimes) ihas iincreased ithe inet iprofit iper iunit ifrom i$0.4 ito i$0.9 i(that iis, i2.25 itimes).

However, ithe icontribution imargin, iwhich igets icalculated iwith irespect ito ionly ithe ivariable icost, iwill ibe:

(Sale iPrice−TVC)= i($2.0−$0.6) i=$1.4 iper iUnit

The icontribution imargin iremains ithe isame, ieven iwhen ithe inumber iof iunits iproduced iand isold ihas idoubled.

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