Douglas (2012) defines contribution analysis as a cost-benefit analysis method that confines costs to incremental costs while benefits are linked to incremental revenues that result from a decision being made. The purpose of contribution analysis is to measure the contribution of a decision (Douglas, 2012). The contribution of a decision can be defined “as the excess of incremental revenues over incremental costs, and it is called the contribution because it contributes to the firm’s fixed and unavoidable costs, and also to profits if total revenues are more than total costs” (Douglas, 2012, Sec. 6.1, Para. 1).
Incremental costs are the costs that change because of a decision and incremental revenues are those that are received because of the decision (Douglas, 2012). The contribution analysis can determine the contribution margin of a product by taking the price per unit of a product and subtracting the average variable cost per unit of a product (Douglas, 2012). A contribution analysis could be used by a retailer to determine if lowering the price on a product would still result in a positive contribution margin for that product.
