(23 Jan 2014, 10:18 pm)Adam wrote Last week in my Business class, we came across an idea that may explain why GNE keep some of their not-so-well-used services. (I know this may get quite dreary and quite confusing but please bear with me. It's also a good excuse for some revision).
Anyway, the idea is based on a thing called Contribution, (calculated by taking the Selling Price away from the Variable Costs), which helps a business to see how well a product (or service in this case) contributes to the overall Fixed Costs of the company.
Even if a product or service is making a loss, that can be a good thing (but only in the short-term. If in the long-term, then the company will seek to change its strategy to increase the profitability of that product/service that is making a loss, hence many changes to some bus services, such as the X3) as it can help to maximise the profitability of other bus routes as the total Fixed Costs will be "shared out" equally between more bus routes. If the product/service was to be withdrawn, then the equivalent amount of Fixed Costs would need to be "shared out" amongst the rest of the routes, increasing that figure for each service.
As an example, if a business has 3 products/services (for argument's sake) and has Fixed Costs of £30,000 evenly spread out (i.e. £10,000 each). Product A makes a profit of £12,000 and Product B make a profit of £3,000, but Product C makes a loss of £5,000. I know it sounds as if Product C should be withdrawn, but let's see what happens.
Product C is then withdrawn, so the Fixed Costs that Product C contributed now have to be spread equally into the remaining Products, A & B.
Now, the £30,000 of Fixed Costs has to be equally distributed between Products A & B, so their Fixed Costs are now raised to £15,000 each. That means that the profit of Product A has reduced to £7,000 (original profit (£12,000) - £5,000 (share of increased Fixed Costs), whilst Product B now makes a loss of £2,000 (same calculation).
So then, it is better to continue producing Product C as it helps to increase the profitability of the other products/services :)
Sorry......
I get what you are saying, but if those fixed costs were reduced by natural savings or other means such as streamlining, then it is possible to maintain or increase profits with the two remaining products.
So if product c (x3) is cancelled, costs can be reduced for waged staff, fuel costs are also reduced and if justified, vehicles sold.
If that was the case, then the initial 30k costs can now be 20k and the profits for products a and b maintained.