Should you sell or process further?

Formulation of the problem

A decision to sell or process further consists in choosing either to sell a product as it is or to work a bit more on it to increase its market value. Note that when the initial product has no market value, this decision is rather called a scrap or rework decision. Again, this can be considered a short-term decision if no investment is necessary to do the additional processing or rework.

The sell or process (or scrap of rework) decision consists in determining whether to sell a product as is or add additional features so that it can be sold for a higher price.

Classification based on relevance

The key point here is that the book value of the product is irrelevant at the time of the decision because it is a sunk cost. What is relevant is the market value of the product as it is (forgone if the manager chooses to process it further), the market value of the product after further processing (forgone if the manager chooses to sell the product as it is), and the additional costs of processing (which are avoided if the manager chooses to sell the product as it is).

If the capacity is constrained, it is also important to consider opportunity costs since processing further may take capacity away from other product lines. The contribution margin lost on other products is thus relevant as well.

In this end, if the increased revenue from added features (i.e. increase in market value due to further processing) is enough to offset the incremental costs (i.e. costs of further processing and contribution margin lost on other products), the company should process further; otherwise it is better off selling the product as is.

Net Economic Impact and indifference points

In the next example, I investogate what would be the impact of making the Cosmo more appealing (for instance adding an umbrella and and a slice of orange). This would allow increasing the selling price from 8 to 8.5, without affecting the sales volumes of 1,000, but would also increase the unit variable costs by 0.25 and the fixed costs by 200. These three impacts are made visible in the following equation:

\[ \begin{aligned} NEI & = + Q \times \Delta P && - Q \times \Delta V_c && - \Delta FC \\ & = + Q \times (P_A - P_B) && - Q \times (P_A - P_B) && - \Delta FC \end{aligned} \]

This time, since there are four different estimates or changes (\(Q\), \(\Delta P\), \(\Delta V_c\), and \(\Delta FC\)); you can compute indifference points for each. You can download here data and solutions if you did not already.

Qualitative factors

Here, there is relatively little to take into account as this kind of decision is relatively simple and mostly economic. It may however be worthwhile to think about environmental consequences of further processing or not. Reworking or recycling a product may be more expensive from the companies’ perspective and yet better for the environment. The cost of waste in indeed still greatly underestimated in practice. There may also be some learning benefits in trying out adding features, as well as effects on reputation and image coming from limited editions for instance.

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