Contribution

Contribution (per unit) is the selling price minus the variable cost per unit (1) — the amount each unit sold contributes towards covering fixed costs and then profit (1).

Contribution per unit = £30 − £18 = £12 (Knowledge 1). Total contribution = £12 × 5,000 = £60,000 (Application 2). Profit = total contribution − fixed costs = 60,000 − 45,000 = £15,000 (Analysis 1).

Because the offered price is above the variable cost, the order makes a positive contribution (Knowledge + Application). Since OrderCo has spare capacity and its fixed costs are already covered by normal sales, this extra contribution is all additional profit — so on the numbers, accepting the order increases OrderCo's profit at no extra fixed cost (Analysis).

However, OrderCo should weigh the risks (Knowledge + Application). The price is below its normal price, so if regular customers discover it they may demand the same discount, or the low price may cheapen the brand; and if the order actually uses capacity needed for full-price work, the lost contribution there would outweigh the gain (Analysis). On balance, OrderCo should accept the order as a genuine one-off — since it adds contribution and profit with spare capacity — provided it can prevent the low price from undermining its full-price sales or brand.

In the short term, accepting orders that make a positive contribution can make sense for DiscountOrders. When it has spare production capacity and its fixed costs — factory overheads, plant depreciation and salaried staff — are already covered, each extra order's contribution is additional profit, so filling idle machine time with low-price work adds to profit rather than leaving capacity under-utilised.

However, as a regular, long-term approach this is risky. Each order makes only a small contribution over variable cost, and DiscountOrders still has substantial fixed costs to cover — in the long run, a stream of tiny contributions may not cover its fixed overheads, so it could make an overall loss (contribution is not profit). Habitually accepting low-price orders also absorbs capacity on the line that could run higher-contribution full-price work (an opportunity cost), and trains customers to expect discounts, cheapening its brand and eroding its normal price points.

Whether this is sensible long-term therefore depends on DiscountOrders' capacity and pricing strategy. As an occasional way to use genuinely spare capacity, positive-contribution orders are sensible. But as a regular strategy, it is not sensible long-term: it risks failing to cover fixed overheads, displacing better-paying production runs, and undermining its pricing and brand. DiscountOrders should therefore accept low-price orders selectively — only to fill genuinely spare capacity without displacing full-price work — and ensure its overall pricing covers fixed costs and protects its brand, rather than relying on small contributions as a long-term model.

On a simple contribution test the order looks acceptable — its price exceeds variable cost, so it makes a positive contribution. But CraftMake operating near full capacity changes the analysis dramatically.

The case for accepting. The order makes a positive contribution (price > variable cost), so in isolation it adds to CraftMake's contribution and could boost profit and factory utilisation. A large order also brings guaranteed volume to fill the line.

The case against. However, because CraftMake is near full capacity, taking on the order would displace its normal full-price production runs — this is the crucial point. The order's contribution must be compared not with zero but with the higher contribution CraftMake earns on the full-price work it would have to turn away to free up the machine hours. If the special order's contribution per unit is lower than its normal work's (which it is, being below normal price), accepting it could actually reduce total contribution and profit — an opportunity cost on scarce capacity. The below-normal price could also anger full-price customers and cheapen CraftMake's brand.

Judgement. CraftMake should probably reject this order, or only accept part of it, precisely because it is near full capacity. The positive-contribution rule that justifies special orders assumes spare capacity — which CraftMake lacks. With little spare capacity, the order would displace higher-contribution full-price production, so the real cost is the contribution lost on that work, likely outweighing the gain. CraftMake should accept only if it has (or can create) genuine spare capacity — for example by adding a shift — or if the strategic benefits (a valuable new customer, filling a genuine order-book gap) justify it, and even then guard against undermining full-price customers. The decisive factor is capacity: at full capacity, a below-normal-price order that displaces better-paying work is usually not worth accepting.

Contribution analysis is a powerful short-run decision tool, and Summit relies on it — but as a technique that focuses on variable costs and the short run, its usefulness depends on the type of decision, capacity, and whether Summit remembers its limits.

Why contribution analysis is useful. Contribution (price − variable cost per unit) is ideal for short-run decisions because, in the short run, fixed costs — factory overheads, plant depreciation and salaried staff — don't change, so decisions should be judged by their effect on contribution. This lets Summit make sound special-order decisions (accept below-normal-price orders that still make a positive contribution when it has spare capacity), make-or-buy decisions (compare the variable cost of producing a component in-house with the buying-in price), and resource-allocation decisions (prioritise the product with the highest contribution per unit of a scarce resource, such as per machine hour). It also underpins break-even and margin-of-safety analysis. For Summit's frequent short-term pricing and order-acceptance choices, contribution gives a quick, logical, quantified basis for decisions.

Its limitations. However, contribution analysis has important weaknesses. It is a short-run tool: in the long run, Summit must cover all its costs, so accepting a stream of low-contribution orders that barely exceed variable cost would fail to cover fixed overheads and produce an overall loss — contribution is not profit. Its decisions assume spare capacity: at or near full capacity, accepting a low-contribution order displaces higher-contribution production runs (an opportunity cost the simple rule ignores). And it is purely quantitative, ignoring qualitative effects — a cheap special order can anger full-price customers and cheapen the brand.

What it depends on. How useful contribution analysis is for Summit depends on several factors. It depends on whether the decision is short-run (where it excels) or long-run (where fixed overheads must be covered). It depends on Summit's capacity — the special-order logic only holds with genuine spare capacity on the line. It depends on the reliability of its cost data (accurate variable costs per unit — materials and direct labour). And it depends on whether Summit combines the contribution figure with qualitative judgement (brand, customer relationships) rather than following it mechanically.

Conclusion. On balance, contribution analysis is highly useful for Summit's short-term decisions but must be applied with care. For quick pricing, special-order, make-or-buy and resource-allocation choices — especially with spare capacity — it provides an excellent, logical, quantified basis, so Summit is right to use it. But its usefulness is conditional: it works for the short run and with spare capacity, and Summit must not let it drive long-run decisions (where fixed overheads must be covered), decisions at full capacity (where opportunity cost on scarce machine hours matters), or decisions with big qualitative stakes (brand, customer fairness). Used within these limits — as a short-run decision aid combined with judgement about capacity, the long run and qualitative effects — contribution analysis is very useful; applied blindly to every decision, it can mislead Summit into unprofitable or brand-damaging choices. Its usefulness therefore depends less on the technique than on Summit applying it to the right (short-run, spare-capacity) decisions and remembering that contribution is not profit.