Question

Discussion Question: Your friend remarked, “A company will never drop a product from its product line that has a positive contribution margin. It will want to garner every bit of profit that it can.” Is this true in all cases? What are the risks and benefits of evaluating product continuation or implementation using the contribution margin?

Answer 1

Solution:

I believe that this is not true in all cases, "A company will never drop a product from its product line that has a positive contribution margin". It is important considerd avoidable fixed cost while evaluating dropping or continuing a product. If avoidable fixed cost is higher than positive contribution margin from the product then company must drop the product, however if avoidable is lesser than contribution margin then company should not drop the product. Further if the company is capable of finding another product that generates a higher profit margin and the company is only able to produce one product due to limited resources. The company may also drop a product line that generates lower contribution margin.

The risk of evaluating product continuation or implementation is that we lose out on unanticipated increase in demand of the product that is dropped. The benefit of this analysis is that we know which products to drop in order to maintain a high profit level for all the products that are produced by the company.