Operations management

Table of Contents

1. Topic pack - Operations management - introduction
2. Operations Management (OM) - Introduction
3. 5.1 Production methods notes
4. 5.1 Production methods - questions
5. 5.2 Costs and revenues - notes
   1. Costs and revenues
   2. Types of costs
   3. Costs and revenue - shape of cost curves
   4. Costs - fixed and variable - examples
   5. Revenue
   6. Mattel 1Q Profit Falls On Higher Expenses
   7. Costs and decisions
   8. Contribution to fixed costs
   9. Contribution analysis for multi-product firms
   10. Special orders
   11. Cost centres and profit centres
   12. Why have cost and profit centres?
   13. Apportioning costs to profit and cost centres
   14. Full Costing
   15. Absorption costing
6. 5.2 Costs and revenues - questions
7. 5.3 Break-even analysis - notes
8. 5.3 Break-even analysis - questions
9. 5.3 Break-even analysis - simulations and activities
10. 5.4 Quality assurance - notes
11. 5.4 Quality assurance - questions and activities
12. 5.5 Location - notes
13. Innovation - notes (HL only)
14. 5.6 Innovation - questions
15. 5.7 Production planning - notes
16. 5.7 Production planning - questions
17. 5.8 Project management - notes (HL only)
18. 5.8 Project management - questions (HL only)
19. Print View

Contribution analysis for multi-product firms

Calculating the profitability of a product relies on the firm being able to establish the costs that it incurs in production. However, firms that manufacture more than one product may do so in shared facilities. For example, a firm may have one factory containing three product lines. For each product, it may be possible to identify exactly the amount of raw materials being used, the cost of the employees working on that line and additional costs such as transport and packaging. These direct costs can be deducted from the revenues that product earns. However, what does the firm then do with the bills for utilities, such as electricity, water and gas? Even more problematic are back-office expenses, such as the salaries of support staff in IT, Marketing or Human Relations departments - how are their salaries allocated?

Contribution analysis works on the principle that any division of these costs is likely to be arbitrary and inaccurate. For example, any employee working in marketing would have to record every minute spent working on the marketing of a particular product so that the correct proportion of his/her salary could be charged to that product. However, how would the charge be made if the employee was working on a promotion for the firm itself, rather than a particular product?

Contribution analysis adopts the principle that only the costs directly attributable to a product will be allocated and deducted from revenue and that the remaining figure is that product's contribution to the unpaid fixed and indirect costs (overheads). To calculate whether a multiproduct firm makes a profit overall, the contributions for every product are totalled and then compared to the unpaid fixed and indirect costs.

The following formula is then used to calculate the firm's profit:

Profit = Total contribution - (Total fixed costs + total indirect costs)

Using this method of unapportioned fixed costs and indirect costs means that a product may be retained as long as it makes a positive contribution.

This method of costing can be used for the following:

• Setting of product priorities - the products with the highest contribution are considered the most viable and given the highest investment/marketing priority. Look again at McDonalds Soups. Soup variety G makes the greatest contribution per unit, so should be supported. However, add quantities and the picture might change.

The situation appears very different once demand is factored into the analysis. Soup variety F now appears to be the best proposition.

• Product portfolio management - any new product will have to earn more contribution than the one it replaces. However, the contribution used (unit or total) will affect the result as illustrated above.
• Make or buy decisions - these are decisions about whether the firm should produce goods themselves or buy them in.
• Acceptance of special orders - this method helps firms, which do not usually use contribution costing, come to a decision on whether to supply at a price different to the one it normally charges (see next page for further details).