When the sales department wants to know which products to push the hardest, the accounting manager prints out a contribution margin report, and recommends whatever has the highest margin. Unfortunately, this approach ignores the amount of production time that a product requires in the manufacturing bottleneck operation. If a high-margin product requires an extensive amount of production time in the bottleneck, or its reject rate is so high that extra product must be manufactured, then the company would make more money producing higher volumes of a lower-margin product.
For example, ABC Company has two products: Product High has a contribution margin of 40% and Product Low has a margin of 25%. Product High requires four hours of production time, while Product Low needs only one hour of production time. Both products sell for $250. In a typical 8-hour work day, the contribution margin on Product High would be $200 (2 units x $250 price x 40% margin), while the margin on Product Low would be $500 (8 units x $250 price x 25% margin). In this example, production time is the key profit driver, not the contribution margin.
How to create reports containing profit velocity? That is not simple, since the calculation combines financial information (the contribution margin) and operating information (production time), which are stored in different places. If a company is using an enterprise resources planning (ERP) system, then both types of information will be available somewhere in the ERP database, and will only require a report writer to combine onto a single report. Otherwise, combining the information using a data warehouse or electronic spreadsheet are the only remaining alternatives.