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 Revenue |
15,000 |
24,000 |
|
Processing Cost |
- |
(5,000) |
|
Packaging & storage |
2,000 |
(6,000) |
|
Transport |
3,000 |
(1,000) |
|
Total cost |
10,000 |
12,000 |
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:
| Aspro | Brufo | |
|---|---|---|
|
Sales Revenue |
10,000 |
15,000 |
|
Joint cost |
(6,000) |
(9,000) |
|
Contribution |
4,000 |
6,000 |
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.