Limiting factor analysis
Limiting factor analysis ranks products by contribution per unit of a scarce resource, such as machine hours, rather than per unit of output. It finds the production mix that maximises profit when one resource is capped.
See it move
A workshop has 800 machine hours. Product P earns €20 contribution per unit and needs 1 hour, so €20 per hour; Product Q earns €36 per unit but needs 2 hours, so only €18 per hour. Ranked by contribution per hour, P's 300-unit demand takes 300 hours first; the remaining 500 hours make 250 units of Q. Total contribution is €6,000 plus €9,000, or €15,000.
The formula
Variables
- Contribution per unit of the limiting factor (€ per hour (or per unit of scarce resource))
- Contribution margin per unit (€)
- Units of the limiting factor needed per unit of product (hours (or other resource units))
Ranks products by how much contribution each earns per hour (or other scarce resource) they consume, not per unit sold.
Check yourself
Labour hours are limited to 600 this month. Product X earns a contribution margin of €18 per unit and needs 2 labour hours per unit. Product Y earns €35 per unit and needs 5 labour hours per unit. Demand for both is unlimited. If the company dedicates all 600 hours to whichever product maximises contribution, what is the resulting total contribution?