Question 11.6: A business provides three different services, as follows:
A business provides three different services, as follows:
| Service (code name) | AX107 | AX109 | AX220 |
| Selling price per unit | $500 | $400 | $650 |
| Variable cost per unit | $250 | $200 | $350 |
| Contribution per unit | $250 | $200 | $300 |
| Labour time per unit | 5 hours | 3 hours | 6 hours |
Within reason, the market will take as many units of each service as available, but the ability to provide the service is limited by the availability of skilled labour. Fixed costs are not affected by the choice of service provided, because all three services use the same production facilities. What is the most profitable service, given the limited number of labour hours available?
The most profitable service is AX109 because it generates a contribution of $66.67(i.e. $200/3) per hour. The other two generate only $50.00 each per hour ($250/5 and $300/6).
Your first reaction may have been that the business should provide service AX220 only, because this is the one that yields the highest contribution per unit sold. If so, you are mistakenly thinking that the ability to sell is the limiting factor. If you are not convinced by the above analysis, take an imaginary number of available labour hours and ask yourself what is the maximum contribution (and, therefore, profit) that could be made by providing each service exclusively. Bear in mind that there is no shortage of anything else, including market demand, just a shortage of labour.