Three products of Nestle

The products listed below are priced in the Nigerian local currency Naira.

Milo 500g                                            $700

Variable Cost                                      $300

Contribution Margin                           $400

 

Maggi Seasoning (100 cubes)             $220

Variable Cost                                      $140

Contribution Margin                           $80

 

Nescafe Gold Blend 100g                  $1075

Variable Cost                                      $800

Contribution Margin                           $275

 

For this step the assumption that the sales price and the variable cost remains the same and there are no economies of scale gained in larger production units or sales discounts for larger purchases. In practice both of these would normally exist.

The contribution margin could change depending on the volume of purchases as larger retailers may get better prices for bulk purchasing. This would lower the sales prices thus changing the contribution margin. Therefor different customers would have different contribution margin for the same product. In turn the larger production of a particular product could lower the variable cost and also change the contribution margin.  

The contribution margins will not be the same for all products. There are several reasons for this. Firstly if all the contribution margins were the same the company would not be competitive in the marketplace. If all the above three products had the same contribution margin as the Milo tin of $400 this would affect the selling price. The Maggi seasoning cubes would now be sold at a price of $540, more than double the original price. The customer may not want to pay this price and the company will see reduced sales and therefore less profit. The sales price can also be determined by the marketplace and increased competition or a monopoly can alter the contribution margin of a product.

Also there are different processes involved for different products. Each product contains different ingredients which come at different costs. These differences will impact on the variable costs of each product and thus alter the contribution margin. For example some raw materials may need to be imported and some can be produced locally resulting in different costs. 

The marketing department can also have an impact on the contribution margin. How a company markets itself in contrast to other competitors will alter the contribution margin. Although in a different category to Nestle this can be seen in the technology landscape. Apple markets itself as a premium product and through its very successful marketing team enjoys higher margins than much of the sector. A company marketing itself as a cheaper alternative may enjoy more sales but lower contribution margins.

A firm may produce a range of products with different contribution margins for varying reasons. The products may be complimentary products. For example if Apple had only stayed with the Mac computer it would not have reached the popularity it enjoys today. The interconnectivity of its products is an important part of its success in the highly competitive technology sector.

 

Profitability is also a reason to produce multiple products. By only producing the product with the highest contribution margin you are limiting sales. There is only so much of one product customers can buy. To increase profitability and stay relevant other products need to be offered. Although they may have a lower contribution margin they may still generate profits above the cost of capital and increase overall profits.

 

A potential constraint on Nestle would be changing consumer attitudes. This may involve consumer tastes, attitudes towards health and attitudes towards labour or resource practices. Changing attitudes towards healthier products would impact on the amount of Milo it may produce or awareness of labour practices could impact on the popularity of products such as Milo or Nescafe.

Resource quality and cost may act as a constraint. Improved labour practices may increase the cost of raw materials and thus impact the amount of production.

The political environment can change and act as a constraint on productions. For example a new government could demand more production locally and less imports. It may introduce a quota system or simply increase taxes on imports. The economic environment can impact on the types of food people will buy. A luxury item such as Nescafe Gold may become unpopular in down times and less expensive brands may become more popular. This may be especially important in Nigeria as the country’s economy is plagued by corruption, high unemployment and linked to the prices of oil which in recent times as fallen.