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A net contribution is a figure that aids in identifying the amount of the sales price of a given item after all expenses have been subtracted from the revenue generated by the purchase of those goods by consumers. By subtracting all the expenses associated with the good or service from all the revenue sources relevant to that product, it is possible to determine how much of a benefit or contribution those expenses make to the generation of profit for the business. This particular calculation provides a quick snapshot of how well a product line is doing in terms of generating a decent profit margin, and can serve as the basis for finding ways to improve that net profit.
The basic net contribution formula is very straightforward. The first step involves identifying all expenses that are associated with the creation and sale of the product. Once this total is determined, it is necessary to identify all sources of revenue that are connected with the product. Subtracting expenses from the revenue results in identifying whether or not any profit was generated. A positive net contribution means that the company did in fact cover all expenses and realized at least some profit. At the same time, a negative one means that it cost the company more to produce the goods than the revenue that was produced from the effort, a situation that requires immediate attention.
One way to understand the concept of a net contribution is to consider a situation in which a company adds a sales campaign for a new product, with that campaign costing $500,000 US dollars. The campaign proves successful and generates revenue of $750,000 USD in the ways of sales of the targeted product. As a result, the net contribution of that added expense was an additional $250,000 USD of revenue for the company.
Calculating a net contribution may involve focusing on a specific project or product, or have to do with the overall costs of operating a business that manufactures several different products simultaneously. In any incarnation, the idea is to identify any remaining amount of revenue that is available to the company after production and other expenses are settled. Monitoring the movement of the net contribution from one accounting period to the next can help a company track its own growth pattern, both in terms of positive and negative growth. The results of calculating the net contribution help to set the stage for making changes to the production process as well as marketing and other factors so that the company can enjoy a greater profit margin in later periods.
The problem is, too many companies simply cut costs to keep a product on the market by reducing the quality of the materials used or laying off employees, forcing fewer people to work harder to produce the same number of products.
There is no easy solution to address negative net contribution, and it is tough to get the public to look at a product they weren't buying in the first place in a whole new light.
While a negative net contribution usually spells trouble for the future of a product, it does not necessarily have to mean that production of the product must stop.
Once a company puts enough time and resources into developing a new product that it feels that product can be made and sold, it is probably reluctant to give up on that product without first brainstorming ways to make changes to help it sell better or to reduce production costs.
This is where the product development and marketing teams must work together and, perhaps, go back to the drawing board to reinvent the product, so to speak.
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