How to Determine Optimal Product Mix

Posted by: BramallP Post Date: 11th March 2016

A common consideration within the industrial sector is product mix and limiting factors. These affect the products a company can viably offer, how many orders they can fulfil, and how much profit they are able to make.

What is product mix?

How to determine optimal product mix

A company’s product mix is the range of products it offers. Companies are often reluctant to limit production of a particular product, especially if it is selling well. In most cases, the more you make, the more potential there is for profit generation.

However, in some cases it is wise to limit production. Let’s take trainers as an example. Some companies will only make a certain number of trainers to prevent a loss in value. Limiting production protects exclusivity, helping to maintain or increase value.

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Limiting factors

The product range companies can offer is affected by what are called limiting factors; factors that limit the ability to produce products, such as the availability of staff and materials. It may not be possible to fulfil all orders when only so much of certain products can be made, and it must be decided which orders should be fulfilled.

Determining the optimal product mix

Where there are limiting factors, you need to work out which product mix will provide the highest return; ie. the optimal product mix. Let’s take a step-by-step look at how this is done, using the example of Company A, which offers three products.

Product123
Selling price£25£20£15
Material @ £3 per kg£9£9£6
Labour @ £8 per hour£8£6£6
Product demand (units)100150125

 

Company A has sufficient staff to cover the labour hours that need to be worked to produce all of the units required. However, they can only source 675kg of material. The task now will be to decide on the optimal product mix, taking into account the limiting factor of material.

1. We start by deciding the amount of material in kilograms that would be required if we were to produce all of the units.

Product123
Kg per unit3 (£9/£3 per kg)3 (£9/£3 per kg)2 (£6/£3 per kg)
Units100150125
Kg required300450250

 

2. The next step is to see how much contribution (profit) is made per unit.

Product123
Selling price£25£20£15
Material @ £3 per kg£9£9£6
Labour @ £8 per hour£8£6£6
Contribution per unit£8£5£3

 

3. Now we know how much profit we make per unit, we need to decide how much profit each kilogram is worth in a particular unit, and rank units in terms of profitability.

Product123
Contribution£8£5£3
Kg per unit332
Contribution per kg£2.67£1.67£1.50
Rank (best contribution)123

 

4. We now know which unit will make us the most profit per kilogram, so we will fulfil all orders for this product, and as much as possible of the next most profitable product.

Production numbers will look like this:

Product123
Units100125
Kg required300375

 

As you can see from the above figures, we have enough kilograms to produce all of product 1. We then have 375kg left, so we will use that to make as many of product 2 as possible.

If you would like to build a greater understanding of this and similar topics, you might consider a professional accounting qualification. How to determine optimal product mix is examined during the AAT qualification, as well as on our CIMA and ACCA courses.

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