Dropping a line or Product

Diversification of Products:

In order to capture a new market or to utilise idle facilities etc., it may so happen that a new product may be introduced in the market together with the existing one. Naturally, the question arises before us whether the same will be a profitable product one.

In this regard it may be mentioned that the new product may be introduced only when the same is capable of contributing something against fixed cost and profit. Fixed cost will not be considered here on the assumption that the same will not increase, i.e., the new product will be produced out of existing resources.

Marginal Costing Application # 3. Selection of Most Profitable Product-Mix:

If any firm produces more than one product it may have to decide in what ratio should the products be produced or sold in order to earn maximum profit. However, the marginal costing techniques help us to a great extent while determining the most profitable product or sales mix.

Contribution under various mix will be determined first. Then the product which gives the highest contribution must be given the highest priority, and vice versa. Similarly, any product which gives negative contribution should be discontinued.

The following illustration will, however, make the principle clear:

Illustration:

The directors of a company are considering sales budget for the next budget period. From the following information you are required to show clearly to management:

(i) The marginal product cost and the contribution per unit;

(ii) The total contribution resulting from each of following sale mixtures;

Sales Mixture:

(a) 100 units of product A and 200 of B

(b) 150 units of product A and 150 of B

(c) 200 units of product A and 100 of B

Recommend which of the sale-mixtures should be adopted.

Solution:

(ii) From the above Comparative Contribution statement, it becomes clear that as P/V Ratio of Product A is higher in comparison with the Product B, Product A is more profitable one. And, as such, the mixtures which consider the maximum number of Product A would be the most profitable one which is proved from the following table:

Sales Mixture (C) i.e., 200 units of Product A and 100 units of Product B will yield highest contribution.