A relevant cost is one that differs between the alternatives and lies in the future. Anything else — sunk, or shared by both alternatives — stays out of the calculation no matter how large the amount.
1 Accepting a special order
A new customer asks for 500 units at SAR 150, while the usual price is 200. Full cost per unit is 180 (120 variable and 60 allocated fixed). The plant has idle capacity, and the order will not affect existing customers.
| Selling price per unit | 150 |
| Variable cost per unit | (120) |
| Contribution margin per unit | 30 |
| × 500 units | SAR 15,000 additional profit |
The decision: accept. The fixed costs will be paid anyway, and the SAR 60 of allocated fixed cost is not an additional cost of this order.
On three conditions: that idle capacity genuinely exists · that the price does not leak to existing customers · that the order does not create a permanent expectation of that price.
2 Make or buy?
Making the part in-house costs SAR 45 (30 variable + 15 allocated fixed), a supplier offers it at SAR 38 per unit, and the annual requirement is 10,000 units.
| Item | Make | Buy |
|---|---|---|
| Variable cost (disappears if we buy) | 300,000 | — |
| Purchase price | — | 380,000 |
| Allocated fixed cost (stays either way) | 150,000 | 150,000 |
| Total | 450,000 | 530,000 |
The decision: keep making it. Buying looks cheaper per unit, but the cost that actually disappears is the variable 30 only, so buying at 38 adds SAR 8 per unit.
Unless the freed capacity can be used for output generating a contribution margin above SAR 80,000 a year — at which point opportunity cost enters and the decision flips.
3 Dropping a line or a product
The rule
A line with a positive contribution margin is not dropped merely because it looks loss-making after fixed costs are allocated to it. Dropping it loses you the margin while the fixed costs remain — so the loss grows.
| Item | Current position | After dropping |
|---|---|---|
| Contribution margin of the line | 120,000 | — |
| Unavoidable fixed costs | (150,000) | (150,000) |
| Result | (30,000) | (150,000) |
Drop the line if: its contribution margin is negative, or a large part of its fixed costs is avoidable, or there is an alternative use of its resources with a higher return.
4 Choosing under a scarce resource
When capacity is limited — machine hours or a scarce material — the criterion is not the highest contribution margin per unit, but the highest contribution margin per unit of the scarce resource.
| Item | Product A | Product B |
|---|---|---|
| Contribution margin per unit | 90 | 60 |
| Machine hours per unit | 3 | 1.5 |
| Margin per machine hour | 30 | 40 |
The result: Product A looks better with its higher margin per unit, but B earns a higher margin per machine hour. So if machine hours are the constraint, priority goes to B.
And do not forget the non-quantitative side
The numbers settle part of the decision, not all of it. A long relationship with a customer, a supplier’s quality, the effect on team morale, or the risk of depending on a single party — all of these belong explicitly in the recommendation even when they carry no riyal figure.
Lesson summary
- The decision rests only on the costs and revenues that change because of it.
- A special order is accepted if it covers the variable cost and more, with idle capacity available.
- In make or buy, compare what actually disappears when you buy, not the full cost.
- A line with a positive contribution margin is not dropped while its fixed costs are unavoidable.
- Under a constraint, rank products by margin per unit of the scarce resource.
5 Test yourself
Three quick questions
Choose the answer you think is correct — the result appears immediately.
1. A special order priced above variable cost, with idle capacity available. What is the decision?
With idle capacity, any positive contribution margin increases profit — provided the existing market is not damaged.
2. A line has a contribution margin of 120,000 and unavoidable fixed costs of 150,000. What happens if it is dropped?
The fixed costs remain after the line is dropped, and the business loses the whole contribution margin.
3. Capacity is constrained by machine hours. Which product do you prioritise?
The scarce resource is what the return must be maximised on, so the margin is measured relative to it.