Lost contribution margin is the existing contribution margin a company earns from a particular division, market segment or product that it would lose by no longer investing in that particular business activity. Lost contribution margin is one key considered in management decision-making.
Contribution margin is what a company earns when variable costs are subtracted from revenue. In essence, it compares the revenue earned in a business format with the variable costs expended to generate that revenue. Fixed expenses allocated to the revenue-generating activity are subtracted from contribution margin to come up with operating income or loss from conducting business in a certain market or by a particular division within the company.
When a business manager decides that his company is better off discontinuing a product, marketing to a certain segment, or operating a certain division, he should consider the lost contribution margin caused by the decision. For instance, if a product generates $500,000 in revenue with $300,000 in variable costs, lost contribution margin is $200,000 if the product is discontinued. The manager must weigh this lost contribution margin against potential operating income and other uses of the saved variable expenses.
Comparing two alternative business decisions presents another application for lost contribution margin. If a manager compares investment Decision A with investment Decision B, he should look at the contribution margin of each option. He may choose A because of a higher contribution margin opportunity of $200,000, compared to B, with a contribution margin of $150,000. The company only has resources to invest in one option. Contribution margin given up in B is considered lost contribution margin because you will not make that investment.
Sometimes managers break down contribution margin even further to get greater insight when making business decisions. Take the previous description of investment Decision B and its $150,000 lost contribution margin. You could break this down to lost contribution margin per unit by taking the $150,000 and dividing it by 15,000 units produced. This equals a lost contribution margin per unit of $10. This gives the manager a more specific example of how much contribution margin potential he is giving up.