Contribution Pricing - Definition & Meaning
What is Contribution Pricing?
Contribution Pricing is a pricing strategy which maximizes the profit coming from a product. In Contribution Pricing, the price of the product is kept on the basis of its contribution to cover the fixed costs it incurs even if to a minimal level. Here the assumption lies in the difference between the product’s price and the number of items sold and the variable costs involved.
Formulae:
Price - Variable Costs/Unit = Contribution Margin/Unit
Contribution Margin/Unit x Units Sold = Product’s Contribution to Profit
Contributions to Profit From All Products – Firm’s Fixed Costs = Total Firm Profit
Relative Contribution = Product’s Contribution to profit / Production Factor
EXAMPLE
If a product is produced in let us say
Variable Costs : 10$ per piece
Fixed Costs (Total): 100000$
Demand (assumed): 10000 pieces
Now SP should contribute to fixed cost recovery too.
So it has to be above 10$ for sure as variable cost is that much
Now if we keep price at 20$.
It recovers 10$ of variable costs and contributes 10$ back to fixed costs.
for 10000 pieces it would be 10000*10$=100000$ which covers the fixed cost exactly.
Now any price above 20$ will help company maximize profits.
This article has been researched & authored by the Business Concepts Team. It has been reviewed & published by the MBA Skool Team. The content on MBA Skool has been created for educational & academic purpose only.
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