Sell or Process Decisions



Should a business sell its product immediately, or should it sell them at a premium after further processing?

This is a common concern for organizations looking for ways to add more value to their products. A business can increase its profit if the additional revenue from further processing exceeds the extra cost.

Sell-or-process decisions involve the cost-benefit analysis of further processing of a product or service.

When evaluating sell-or-process decisions, it is important to compare the incremental revenue and cost of further processing.

Unavoidable costs incurred before any additional processing takes place are not relevant to sell-or-process decisions.

Example

Lisa, a farmer, is planning for the upcoming harvest of grapes.

The estimated production of fresh grapes for this season is 10 MT.

Lisa will spend $2000 on pre-harvest expenses for preparing the crop.

Two options are available to Lisa for selling grapes.

Option A

Sell fresh grapes to retailers.

The expected selling price of fresh grapes is $1500 / MT.

Packaging would cost $200 / MT.

Transportation cost is estimated at $300 / MT.

Option B

Lisa can dehydrate the fresh grapes in summer and sell them as dry grapes in winter.

10 MT of fresh grapes can be processed into 2 MT of dry grapes.

The price of dry grapes in winter is estimated at $12,000 / MT.

The cost of the dehydration process is $500 / MT of fresh grapes.

Packaging and storage of dry grapes cost $3000 / MT.

Transportation cost of dry grapes is $500 / MT.

Calculate which option will maximize Lisa’s profit.

We need to compare the incremental revenue of each option with its incremental cost.

Option A
Immediate Sale
Option B
Further Process
Sales Revenue15,000   [$1,500 × 10 MT]24,000   [$12,000 × 2 MT]
Processing Cost-(5,000)   [$500 × 10 MT]
Packaging & storage2,000   ($200 × 10 MT)(6,000)   [$3,000 × 2 MT]
Transport3,000   ($300 × 10 MT)(1,000)   [$500 × 2 MT]
Total cost`10,00012,000

Option B is more profitable.

Pre-harvest costs are unavoidable and therefore ignored in the calculation.

Joint Products

Sell-or-process decisions involving joint products should only consider costs after the split-off point (i.e. when joint products can be identified separately).

Joint products are manufactured simultaneously in a joint process and share common inputs.

For example, slaughtering a cow (joint process) produces beef and leather (joint products). The cow is the common input of joint products.

Joint costs (i.e. costs up to the split-off point) are not relevant to the decision as they are unavoidable.

Example

Pharma Inc. produces two medical products from a joint process: Aspro and Brufo.

Information relating to the two products is as follows:

AsproBrufo
$$
Sales revenue10,00015,000
Joint cost(6,000)(9,000)
Contribution4,0006,000

Brufo can be processed further to produce Citro.

Citro can be sold for $20,000 but requires additional processing cost of $3000.

Should Brufo be sold immediately or processed further?

Additional revenue from selling Citro is $5000 ($20,000 - $15,000).

The additional cost of producing Citro is $3000.

Since the incremental revenue from further processing exceeds the additional cost, Citro should be produced.