Improving Profit: Using Contribution Metrics to Boost the Bottom Line by Cleland Keith N

Author:Cleland, Keith N....
Language: eng
Format: epub
Published: 2014-01-30T07:34:59.458000+00:00

Table 13-1. Identifying Contribution1 per Unit2 for Meat Pies

A Wholesale Price per Meat Pie 68 cents

B Ingredient Price 18 cents

C = (A – B) Contribution per Pie 50 cents

D Batch Production per Hour 10,000 pies

E = (C × D) Contribution per Batch-Hour $5,000

F Batch Production Personnel 25

G = (E ÷ F) Contribution per Unit (Production-Hour) $200

The CEO looked puzzled. “I think I can grasp that, but how could the crumpets’ contribution be so low considering they use a lot less labor than meat pies?”

“I agree,” the production manager said in a tone of annoyance. He had been experiencing difficulty holding back. “The fact is, the contribution on most of the products is much the same based on 70 percent markup on factory cost.”

“What do you mean by factory cost?” I asked him.

“Ingredients, direct and indirect labor, supervision, power, depreciation on plant, repairs, and maintenance, rent, phones, and so on.”

“And how do you apportion these costs to the various products?” I asked.

“Direct costs such as ingredients, power, and labor go to the product and the rest are spread in proportion to the direct labor. We also apply a small markup to make a factory profit.” He looked around the table before adding, “And the factory has never failed to make a profit.”

“You say 70 percent is applied to all factory costs to arrive at the selling price, yet the selling price is pretty well dictated by the market, isn’t it?” I asked.

“Mostly it is,” said the CEO, steeped in the traditional approach to costing and pricing.

The meeting adjourned for lunch, during which time we went down to the crumpet line and saw crumpets being packed by hand as they came off the line. “They used to be machine packed into four a pack, but when we went to six a pack and then eight a pack to meet the competition, we had to use hand labor,” said the foreman. “It’s slowed us down quite a bit.” The production manager looked stunned.

After lunch, to avoid getting lost in the detail of costing and pricing issues, I suggested we look at the matter from a different angle altogether and went to the whiteboard.

“The sales target for next year is $30 million. If we take out $10 million for ingredients and packaging, we are left with $20 million gross profit. You are planning on paying for 220,000 direct labor hours, and you are estimating that 75 percent of these hours, or 165,000, will be productive.” I wrote it down on the whiteboard (Table 13-2) and divided $20 million by 165,000 hours to arrive at $121.

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