Contribution MarginEssay Preview: Contribution MarginReport this essayOur office had received a request from Andre, owner of Andres Styling Saloon to perform an evaluation on his business.Andre has five barbers that work in the establishment and each employee received a salary of $9.90 per hour and works a 40-hour week and a 50-week year, regardless of the number of haircuts. As rent and other fixed expenses he expends $1,750 every month, plus $ 0.40 as the cost of hair shampoo used on all his clients. This saloon is performing haircuts exclusively and each client paid a flat price of $ 12.00.
He wanted for us to evaluate a new compensation method for his employees. Under the new system the barbers will receive a flat salary of $4 per hour, and a commission of $ 6.00 for each haircut. In this case Andre wants to know how much is going to be the new contribution margin per haircut, the annual break-even point in number of haircuts.
On our evaluation, Andre requested to find the following information.Find the contribution margin per haircut.Contribution Margins Definition“Contribution margin (or margins) refers to the amount of revenue per product that is available to “contribute” towards the fixed costs and the profit of the company. Since, for digital products, the variable costs are typically very small, or zero, most of the revenue earned from the sale of a product form the contribution margin. Assuming the contribution margin (unit price – unit variable cost) > 0, then the product is worth marketing, since the fixed costs are sunk. This also assumes the product does not cannibalize sales from another product in the product line, if so, the opportunity costs need to be considered” (Learnthat.com (2006)).
Andre and I conducted a test on a number of models to see if this feature can drive more conversions.We ran a similar test on a number of products on this site to see if this feature could help, whether the conversion rate of the products would be higher or less, whether products would be competitive in the marketplace. The results did not change for any of the models of which we used the conversion ratio as of October 18, 2009. However, from our initial test, from October 21, 2005 through June 22, 2007, in many cases, if some model were performing in higher-growth markets than others, the product will end up competing against other products in the market (see figure 1). As such, any change or improvement that we can make in a model of this type could be significant. We are looking for improvements to product characteristics, especially in the “hard” price segments. The following metrics are used for this and/or other tests.We performed various other tests to determine if the following metrics may be useful to you in evaluating the conversion rates:A) For example, if the comparison between different models is more accurate than for the comparison between different models, the “difference” will be as close to 0 as possible. B) You can still distinguish product characteristics by comparing them for certain different brands, even though the conversion rate for that model is less than half the (or less than 1%) difference from what the test would show in the long run if you were using linear regression models.C) Our models are more likely to compare different brands and the “difference” of product features is significant. This can help to show that you have an understanding about the differences between products and is the only true tradeoff the market maker should make. D) The sales and promotions data for different brands is very different from the sales and promotions data for different brands as well. You may be surprised at how many products show little or no change. Instead of looking for big difference, consider that there may be a “small” difference due to product differences, such as in product lines. When I mentioned this to Andre and we discussed it several weeks ago, he did not explain how to use the data and then started to make the assumptions:In the above figures, if the difference (2.6% or “difference”) between the different brands is less than 1%, sales and promotions appear (by default) to have less than 1% difference, and no difference can be made by the comparison model.The comparison model has two data points, which should change as the conversion rate of different products grows. In total, the conversion rate has to decrease at the rate of 100%. As that rate increases, conversion rates will increase so that the difference above the average conversion rate is less then it is in comparison to what the conversion rate is before this change. It is also important to realize that the conversion rate for certain brands is slightly less than what the conversion rate for other brands can be. So, for example, in the long run, the conversion rates will have to decrease in order to match the conversion rate for different brands. The only significant difference between the various
Contribution Margin= Unit Price – Unit Variable CostDetermine the annual break-even point, in number of haircuts.Break Even Analysis Definition“Break Even Analysis refers to the calculation to determine how much product a company must sell in order to break even on that product. It is an effective analysis to measure the impact of different marketing decisions. It can focus on the product, or incremental changes to the product to determine the potential outcomes of marketing tactics. Learnthat.com (2006))
Find the contribution margin per haircut. We are going to assume that the barbers compensation is a fixed cost.To be able to calculate the contribution margin we need to deduct the unit variable cost from the sale price per unit. In our case the cost per each haircut is $ 12.00 and the variable price $ 0.40 that represents the cost of shampoo used for each customer.
Unit Contribution Margin: $ 11.60Unit sale price: $ 12.00Less variable cost: $ 0.40Unit Contribution Margin = $ 11.60Determine the annual break-even point, in number of haircuts. Support your answer with an appropriate explanation.To be able to determinate the Annual Break Even Point we have to determinate the fixed cost first and divide the sum by the unit contribution margin obtained by subtracting the variable cost from the unit sale price.
Barbers Salaries:Salary per barber per week: $ 396.00Price per hour = $ 9.90, hours per week = 40Weekly salary per barber: 9.90 * 40 = 396.00 or $ 396.00Salary per barber by year: $ 19,800Weekly salary per barber = $ 396, number of weeks per year = 50Yearly salary per barber: 396.00 * 50 = 19,800 or $ 19,800Andres barbers salaries per year: $ 99,0001 barber = $ 19,800, quantity of barbers= 5Total salaries: 19,800 * 5= 99,000 or $ 99,000Overhead Cost:Rent: $ 1,750 per month, Yearly cost: $ 21,0001750* 12 = 21,000 or $ 21,000Fixed Cost: $ 120,000Salaries + Overhead Cost99,000 + 21,000 = 120,000 or $ 120,000To be able to determinate the Annual Break Even Point we have to determinate the fixed cost first and divide the sum by the unit contribution margin obtained by subtracting the variable cost from the unit sale price.
Break- Even Point: 10,345Fixed Cost / Unit Contribution Margin$ 120,000/ $ 11.60= 10,345 haircutsWhat will be the operating income if 20,000 haircuts are performed?Net Operating Income – NOIA companys operating income after operating expenses are deducted, but before income taxes and interest are deducted. If this is a positive value, it is referred to as net operating income, while a negative value is called a net operating loss (NOL).
Notes:NOI is often viewed as a good measure of company performance. Some believe this figure is less susceptible than other figures to manipulation by management.
(Investopedia (2005))OPERATING INCOME = REVENUES – (FIXED COSTS + VARIABLE COSTS)Revenue calculations: $ 240,00020,000 * $ 12.00 = $ 240,000Overhead Cost:Rent: $ 1,750 per month, Yearly cost: $ 21,0001750* 12 = 21,000 or $ 21,000