Question

How can a brand be unprofitable in regard of contribution margin ratio? what does it mean when contribution margin ratio is negative %?

Answer 1

The formula for contribution margin ratio is as below

(Sales - variable costs)

------------------------------- X 100

Sales

It is clear from the formula that the contribution margin ratio will become negative only if the value of the numerator turns negative which can happen only when the sales are not enough to cover the variable costs. If a brand or product has a negative contribution margin ratio, it indicates that the variable costs and overhead expenses incurred to produce it exceed its sales. In other words, when contribution margin ratio is negative %, it means that the brand or product is unprofitable as selling it is causing a loss to the organization because the selling price is not adequately covering even the variable costs, what to speak of the fixed costs. A negative contribution margin means that the loss of the organization by selling the brand is more than the amount of fixed costs and expenses incurred to produce it.

The contribution margin ratio is positive when, after recovering the variable costs in full, the selling price also covers the fixed costs and expenses. Hence, in order to turn the negative contribution margin ratio of the brand to positive, the organization must ensure to generate a positive contribution margin from the brand. The two main components which determine the contribution margin of a product are its selling price and variable cost per unit. Hence, to ensure a positive contribution margin from the brand, the organization must consider taking the following measures:

1) Increase the selling price of the brand,

2) Exercise strict control over variable costs to reduce them

3) Use a combination of both these measures given above

If it is not possible to increase the selling price because the brand's customers will not accept an increase in price and shift to some other similar brand(s), it would be probably better for the organization to not produce the brand at all. It needs be always kept in mind that it is better to not sell a product at all than to lose money from your own pocket for selling it.