THE MODEL

COST-VOLUME-PROFIT:
Multi-product firms
 (2.3) MULTI-PRODUCT FIRMS

 Assumption 4. Multiproduct Firms

In the case of multiproduct companies, the combination of
products that the company produces and sells, is assumed stable
for any level of production within the relevant range and within
the timeframe considered (the company produces "a package").

A company produces n-goods/services

• Qi: Quantity produced of the good “i"
• Total produced by the company Q=q1+q2+...+qN

That is, of each Q units produced, q1 are from good/service 1, q2

from good/service 2,... And qN good/service n
 MULTI-PRODUCT FIRMS

 The productive/commercial structure of a multiproduct firm is determined

by α1=q1/Q, α2=q2/Q,... αN=qN/Q
 Two possible interpretations of the above:
a) every unit within Q is a "product package" in which, in each package,
α1=q1/Q units are good 1, α2=q2/Q are good 2,…and αN=qN/Q are good n.

b) Each α is the weight that each product has in the company, such that we
can compute averages for price and cost.

The two interpretations have in common that we could now regard the
company as a single-product firm and use the standard model
c) The company sells a single product that is a "product package"

d) The company sells a product whose price and cost is calculated through the
average
 MULTI-PRODUCT FIRMS

 Examples of interpretation
 A hotel occupies 100 rooms (product 1) per day and serves 200 dishes of food
(product 2) per day between hotel and external customers so in total it sells
300 units of “product”.

a) We can think that the hotel sells a single product which is a package
consisting of 100/300 (α1=1/3) rooms and 200/300 (α2=2/3) meals

b) If the room has a contribution margin (SP-AVC) of 20€ and the dishes of
10€, we can think that the contribution margin for each product sold will
be, on average, (100/300)*20+(200/300)*10=13,3€

 How do I represent the revenue of a company that has sold Q

units/packages in total? What about the costs?
DETERMINATION OF THE CVP MODEL

 The company's profit is equal to Total Revenue minus Total Costs

P=R-TC
 The company's total revenue is equal to the sum of revenue per product

R=q1SP1+...+qNSPN
=Q×α1×SP1+...+Q×αN×SPN
=Q(α1×SP1+...+αN×SPN)

 The total costs are equal to the fixed costs plus the sum of variables of each
product
TC=FC+VC

VC=q ×AVC +...+q ×AVC

1 1 N N

=Q×α ×AVC +...+Q×α ×AVC

1 1 N N

=Q(α ×AVC +...+α ×AVC )

1 1 N N
DETERMINATION OF THE CVP MODEL

We want to find the quantity “of package” to be produced as a function of

profit, fixed costs, average variable costs, selling price and comercial
structure (the structure of the package), i.e. finding the function

Q(P,FC,SP,AVC, α1, α2,..., αN)

We proceed in the same way as in the normal CVP model and we get

P= Q(α1×SP1+...+αN×SPN)-[FC+Q(α1×AVC1+...+αN×AVCN)]

If you isolate Q in one side of the equation, you'll have the solution. Try!!
 DETERMINATION OF THE CVP MODEL

Isolating Q, we get

Interpretation: The numerator is the total net income that we need to generate in
order to fulfill our objectives. The denominator is the "Net Income" (Contribution
Margin) of each "package" the firm sells, which is determined by the sum of the
"units" of each good sold within each package ('s) multiplied by their
corresponding contribution margin. Equivalently, the denominator is the average
contribution margin per unit sold

Notice that is the same formula as the standard one but applying the contribution
margin of the “package sold”
 INTERPRETATION OF THE CVP MODEL
IN MULTI-PRODUCT FIRMS

is the total number of units of products between the N different goods that the firm
should sell.

Equivalently, is the number of packages to be sold, each package containing units

of good/service 1, of good/service 2, …, units of good/service N.

So, since by assumption 4 the composition of the package keeps constant, how
many units of good/service 1 should we sell? And of good/service 2? And of
good/service n?
 INTERPRETATION OF THE CVP MODEL
IN MULTI-PRODUCT FIRMS

is the total number of units of products between the N different goods that the firm
should sell.

Equivalently, is the number of packages to be sold, each package containing units

of good/service 1, of good/service 2, …, units of good/service N.

So, since by assumption 4 the composition of the package keeps constant, how
many units of good/service 1 should we sell? And of good/service 2? And of
good/service n?

…
 BREAK-EVEN POINT IN MULTI-
PRODUCT FIRMS

How many packages should the firm sell to make 0 profits?

And how many units of each product/service should the firm sell in the breack-even
point?

…
 Question

Why can't we solve the multiproduct model as if they were

n independent single-product companies? I.e., Why can’t
we compute the break-even point for each product
independently?
 Question

Why can't we solve the multiproduct model as if they were

n independent single-product companies? I.e., Why can’t
we compute the breack-even point for each product
independently?

Because fixed costs (or at least part of them) are common

to the entire company and cannot be divided (attributed) to
individual products. Therefore, the company should be
treated as a WHOLE.
 EXERCISE 6.7 (a)
Mr Monfort, owner of the company Gatvell SL, owns a 12 meter long boat which he uses
to organize fishing and day trips for groups. The big investment made when buying the
boat implies annual repayments of €25,000. The company also has to pay annual
mooring fees (in the last few years these have been around €3,100) and boat
maintenance (around €7,500).
Mr Monfort is the captain of the boat and receives monthly pay of €2,000. He always
takes a seaman with him as crew which costs him €1,000 per month (12 payments per
year). When customers want to go fishing (normally deep sea fishing) fuel consumption
is around 400 liters. If it is a day trip, consumption does not usually exceed 250 liters.
The average price of fuel over the last year was €0.488/l.
The company provides food and drink for its customers, whether they are going fishing
or on a day trip. A catering company supplies the food (as an average, it costs €55 per
trip) and Mr Monfort takes charge of replacing drinks (around €15 worth are usually
consumed per trip).
Also, if it is a fishing trip, we need to add the bait which is bought in the fishing market
at a cost of €30.
If 70% of trips made in the last few years have been for fishing:
a- Calculate the break-even point in number of trips, if the company charges
€1,100 per fishing trip and €700 per day trip.
 SOLUTION 6.7 (a)
a. First of all, we calculate fixed costs:
Repayments 25,000
Maintenance 7,500
Mooring 3,100
Employee 1,000 x 12 = 12,000
Mr Monfort 2,000 x 12 = 24,000
Total fixed costs 71,600
Then we calculate the average variable costs of the fishing and day trips:
C. diesel for fishing 400 x 0.488 = 195.2
Food & drink 70
Bait 30
Total AVC fishing 295.2

C. diesel day trips 250 x 0.488 = 122

Food and drink 70
Total AVC day trips 192
Now we can calculate the break-even point:
CF
Q pm  
 CM 1   CM 2

71.600
  100.033  100 excursions
0.7  1.100  295.2   0.3  700  192 
 EXERCISE

The company "Black Chicken" owns a slaughterhouse in which it slaughters poultries.

The company sells boneless thighs and breasts to retailers and other processing
companies at 5 euros/kg.

At the same time and as a by-product, it produces concentrated broth tablets. The
tablets are sold in boxes of 12 by 3 euros/box. The fixed costs of these facilities are 3.5
million per year. The variable costs attributable to meat production are EUR 1/kg.
Variable costs per broth tablet are 0.05€.

From each chicken the company gets, on average, 2 kilos of meat and 4 tablets of
broth.

a) How many chickens should you sacrifice to not have losses? And to get 500,
000 euros of profit?

Here there are 2 different ways to solve it (but equivalent). The first makes use of the
step-by-step model. The second considers the company to be a single-product firm.
They're all just as good.
 SOLUTION 1: Step-by-Step

If we use the model as we just saw it, the first thing we need to do is define what a
"product package" is.

A "package" in this case is a unit sold (or produced since according to the assumptions of
the model is the same). We know that if we produce 6 product units (Q) it will be 2 kgs.
(q_meat) chicken and 4 (q_tablets) broth tablets, so

And we can now apply the model directly

If each chicken "produces" 6 units of product, and in the deadlock you need 2386363
product units, we need to sacrifice 397,727 chickens
 SOLUTION 2: Single-Product Firm

We can simplify the problem by assuming that the company only sells chickens. In this
case, the selling price of a chicken would be:

While the AVC per chicken will be

And we can now apply the CVP model as for a single-product company