Using Marginal Costing to Boost Export Sales: A Guide for UK Exporting Companies

Using Marginal Costing to Boost Export Sales: A Guide for UK Exporting Companies

In a competitive global market, UK exporting companies must constantly seek ways to improve profitability, grow their market share, and remain competitive. Marginal costing is one tool that can be invaluable in achieving these goals. This blog will explore the concept of marginal costing, demonstrate its application, and provide worked examples to show how it can help UK exporting companies make strategic decisions that boost export sales.

What is Marginal Costing?

Marginal costing, also known as variable costing, is a management accounting technique that focuses on the variable costs incurred in producing an additional unit of output. These variable costs may include raw materials, direct labour, and other expenses that fluctuate with production volume. Marginal costing is often contrasted with absorption costing, which allocates both fixed and variable costs to products.

The key principle of marginal costing is that fixed costs remain constant regardless of production volume in the short term. Decisions can therefore be based on how additional production impacts profitability.

Key Concepts in Marginal Costing

• Contribution Margin: The difference between sales revenue and variable costs. It represents the amount available to cover fixed costs and contribute to profit.

Formula: Contribution = Sales Revenue - Variable Costs

• Break-Even Analysis: Identifies the sales level at which total revenue equals total costs, resulting in neither profit nor loss.

Formula: Break-Even Sales Volume = Fixed Costs / Contribution per Unit

• Marginal Cost Pricing: A strategy where products are priced based on marginal cost plus a contribution margin.

Benefits of Marginal Costing for Exporting Companies

For UK exporting companies, marginal costing offers several advantages:

1. Pricing Flexibility: Enables companies to set competitive export prices by focusing on variable costs.

2. Break-Even Analysis for Export Markets: Helps assess whether entering new markets is feasible.

3. Optimal Resource Allocation: Guides decisions on which products or markets to prioritize.

4. Promotional Campaign Decisions: Assists in evaluating the impact of discounts or offers on profitability.

How UK Exporting Companies Can Use Marginal Costing

1. Pricing Strategy for Export Markets

Exporting companies often face fierce competition in global markets. Marginal costing enables businesses to price products competitively while ensuring profitability. Instead of covering fixed costs in every sale, exporters can focus on covering variable costs and contributing to fixed costs.

Worked Example 1: Setting Competitive Prices

A UK company exports handcrafted ceramics. The variable costs per unit are as follows:

• Raw materials: £12

• Labour: £8

• Packaging: £5

Total Variable Cost per Unit: £25

The company’s fixed costs are £100,000 per year. If the company wants to price competitively in an overseas market while maintaining a contribution margin of £10 per unit:

Export Price = Variable Cost per Unit + Contribution Margin

Export Price = £25 + £10 = £35

By pricing at £35, the company ensures it covers variable costs and contributes £10 per unit to fixed costs and profit.

2. Evaluating Market Entry Decisions

Before entering a new export market, companies must determine if sales in that market will be profitable. Marginal costing can help calculate the break-even sales volume.

Worked Example 2: Break-Even Analysis

A UK exporter of organic skincare products is considering entering the French market.

• Variable cost per unit: £15

• Planned selling price per unit: £25

• Fixed costs (e.g., marketing and logistics): £50,000

Contribution Margin per Unit = Selling Price - Variable Cost

Contribution Margin = £25 - £15 = £10

Break-Even Sales Volume = Fixed Costs / Contribution per Unit

Break-Even Sales Volume = £50,000 / £10 = 5,000 units

The company needs to sell at least 5,000 units to cover fixed costs and avoid losses. This analysis helps decide whether entering the French market is a viable option.

3. Promotional Campaigns and Discounts

Promotions and discounts can drive export sales but may impact profitability. Marginal costing helps evaluate whether a promotion will still cover variable costs and contribute to fixed costs.

Worked Example 3: Promotional Discounts

A UK manufacturer of premium chocolates exports to Germany. The normal selling price per box is £20, with variable costs of £12. To increase sales during the holiday season, the company considers a 20% discount, reducing the price to £16.

Contribution per Unit at Discounted Price = Discounted Price - Variable Cost

Contribution = £16 - £12 = £4

Although the contribution margin is lower, as long as the company sells enough additional units to cover fixed costs, the promotion can be profitable. If fixed costs are £40,000:

Break-Even Sales Volume = Fixed Costs / Contribution per Unit

Break-Even Sales Volume = £40,000 / £4 = 10,000 units

The company must sell 10,000 boxes at the discounted price to break even during the promotion.

4. Prioritizing Export Products

When resources are limited, marginal costing can help decide which products to focus on. Exporting companies should prioritize products with higher contribution margins.

Worked Example 4: Product Prioritization

A UK exporter of beverages sells two products in an overseas market:

• Product A:

Selling Price = £15

Variable Cost = £10

Contribution Margin = £15 - £10 = £5

• Product B:

Selling Price = £20

Variable Cost = £14

Contribution Margin = £20 - £14 = £6

Product B generates a higher contribution margin and should be prioritized if production capacity is limited.

5. Make-or-Buy Decisions

UK exporting companies often outsource certain production processes. Marginal costing helps determine whether outsourcing is cost-effective.

Worked Example 5: Make-or-Buy Decision

A UK furniture exporter produces tables in-house at a variable cost of £50 per unit. A supplier offers to produce the tables for £48 per unit. Fixed costs for in-house production are £10,000.

If the company outsources:

• Savings on variable costs: £2 per unit

• Fixed costs remain unchanged in the short term

If the company plans to produce 1,000 units:

• Total Cost (In-House) = Variable Costs + Fixed Costs = (£50 × 1,000) + £10,000 = £60,000

• Total Cost (Outsource) = (£48 × 1,000) + £10,000 = £58,000

Outsourcing saves £2,000, making it the better short-term option. However, the company should also consider long-term implications, such as supplier reliability.

Limitations of Marginal Costing

While marginal costing provides valuable insights, it has limitations:

1. Short-Term Focus: Marginal costing assumes fixed costs remain constant, which may not hold true in the long term.

2. Overemphasis on Variable Costs: Fixed costs, though not included in unit calculations, must still be covered overall.

3. Risk of Overtrading: Aggressive pricing based solely on marginal cost may lead to cash flow issues if fixed costs are neglected.

Conclusion

Marginal costing is a powerful tool for UK exporting companies to make informed decisions about pricing, market entry, promotions, product prioritization, and outsourcing. By focusing on variable costs and contribution margins, businesses can remain competitive in global markets while ensuring profitability.

Through the worked examples presented, it is evident that marginal costing enables exporting companies to:

• Set competitive prices that boost sales without sacrificing profit.

• Evaluate the viability of new export markets.

• Make strategic decisions about promotions, product focus, and outsourcing.

By integrating marginal costing into their decision-making processes, UK exporters can gain a clearer understanding of their cost structures and make data-driven choices that support sustainable growth in international markets.