Allocating Fixed Costs (Product Profitability)

Topics

pricing, profits, costs and analysis, product management


Review the activity below or download the PDF student worksheet


Student Discussion Task

Allocating fixed costs to products, in order to more fully assess product profitability, can be determined in different ways with different outcomes.

In the following example, the firm has allocated its fixed costs equally each of its products – what impact does this have?

 

Key Financials Product  A Product  B Product  C Product D TOTAL
Gross profit $4m $1m $2m $3m $10m
Share of fixed costs $1.5m $1.5m $1.5m $1.5m $6m
Net profit $2.5m -$0.5m $0.5m $1.5m $4m

Student Discussion Questions

  1. In the above table, Product B is unprofitable when taking into account fixed costs. What should the firm do with this product; keep it or withdraw it?
  2. If the firm was to withdraw Product B, how would that affect its overall profitability and the profitability of each product?
  3. Other than allocating fixed costs equally, what other approaches could be used? What approach would you recommend in this case?

Related Activities

Financially-driven Marketing Strategy

Price Calculation – Target Profit Pricing

External Information

Calculate Activity-Based Product Costs (textbook chapter)