Recently updated on April 13th, 2023 at 06:02 pm
Companies usually have limited resources, such as limits on space, on the number of workers, or even on the machine capacity needed to produce goods. This reality means that in order to best use limited production capabilities, managers must choose which products to make and sell.
Managerial accountants use a simple technique of dividing contribution margin by a measure of the constrained resource to indicate which products squeeze the most profitability out of constrained resources.
If the limited resource is not a core business activity, it may be appropriate to outsource additional units of the limited resource externally. For example: many organizations have a small legal staff to handle routine activities; if the internal staff becomes fully committed, the organization seeks outside legal counsel.
The long-run solution to the problem of limited resources to perform core activities may be to expand capacity. However, this is usually not feasible in the short run. Economic models suggest that another solution is to reduce demand by increasing the price. Again, this may not be desirable. A hotel, for example, may want to maintain competitive prices. A manufacturer might want to maintain a long-run price to retain customer goodwill to avoid attracting competitors or to prevent accusations of price gouging.
The allocation of limited resources should be made only after a careful consideration of many qualitative factors. The following rule provides a useful starting point in making short-run decisions of how to best use limited resources:
To achieve short-run profit maximization, a for-profit organization should allocate limited resources in a manner that maximizes the contribution per unit of the limited resource.