Contribution Per Limiting Factor / Constraint

Equivalent units work well unless you have one constraint which limits the overall profit of your business.

For example, if you have a small accountancy practice, you may be the constraint because you have to review everything your staff and outsourced accountants do to make sure it is worth of your name.
You can only delegate so much …and a client who needs eight hours of your time…is very different from…a client who needs one hour.

It is the contribution per the use of the limiting factor which is the critical guide to how you can increase profit.

Contribution Per Limiting Factor Example

If we take our manufacturer again with A (2 hours), B (3 hours) and C (5 hours) and the following contribution rates

A has a contribution of £10 on a sales price of £20 – a 50% contribution rate

B has a contribution of £12 on a sales price of £30 – a 40% contribution rate

C has a contribution of £30 on a selling price of £100 – a 30% contribution rate

Without doing the sums, you may think product A is the one to push hard in your sales and marketing, it has much the highest contribution rate percentage.

Especially as it doesn’t take much time at the constraint.

But you would be wrong.

When we calculate contribution per hour of the constraint we find:

A is worth £5 an hour

B is worth £4 an hour

And C is worth £6 an hour.

The way to maximise profit is to sell as much of C as possible at £6 an hour and then fill the capacity with A at £5.

Only if there is spare time is B produced.

Applying This Thinking To Your Business

You may not have any constraints inside your business at the moment because you want more sales orders.

It is still something to look out for in case you successfully sell the wrong product or service.

If you are working the maximum hours, you probably have the opportunity to make more money by looking at your contribution per limiting factor.

We will be looking more at constraints in Pillar 8 on Systemising Your Business.

Return to P1M4 Four Ways To Increase Profit

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