The contribution margin from Beta is $18 and from Alpha is $12. The difference in the contribution margin is because of the higher selling price of Beta.
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The decision will be based on the contribution earned or foregone by adopting an option. In the first option, the company looses a contribution of $11 and in the second option, the company can earn an additional contribution margin of $1 per unit. So, in order to maximize the revenue the company should accept OEMs offer to manufacture the remaining 30000 units. This will result in an additional revenue of $1500000.
From the above figure, it can be seen that the companys contribution becomes negative, if Beta model is switched to Alpha. So, it is advised that the company should adopt the second option. This will help the company to maximize its revenue. By doing so, the company will also be able to make use of its excess capacity. For this, the company will not have to incur any further fixed costs. As a result of this the existing fixed costs will get distributed over the excess units. The utilization of the excess capacity will also lower the Average Cost (AC) of each unit. This is because the Total Cost will now be allocated over a large number of units resulting in a reduced AC.
As the company does not have to incur any extra fixed cost for the excess 100000 units the profit will move up. For the additional units, the only cost that the company has to bear is the Variable Cost as the fixed costs remain fixed irrespective of the level of production.
In order to reduce the cost of production, the company can lower the material cost by setting up production centers near the sources of supply. This will reduce the distribution cost and will thus lower the purchase cost of the material (Kobayshi, 2003).
The company can also lower its overall costs by minimizing waste and ensuring efficient management of the available resources. By purchasing the goods in bulk quantity the company can avail the trade discounts which will reduce the cost of
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