Marginal Costing: Practical Use Cases in Business with Clear Examples

Introduction

Imagine you run a business, and you need to make critical financial decisions—should you lower prices to attract more customers? Should you manufacture in-house or outsource? Should you accept a bulk order at a discounted price? These are everyday challenges for businesses, and marginal costing helps answer these questions logically and profitably.

Marginal costing focuses only on variable costs (costs that change with production, like raw materials and direct labor) while treating fixed costs (rent, salaries, machinery) as unchanged in short-term decision-making.

In this article, we’ll bring real business situations to life with clear examples, making it easy to understand how marginal costing helps companies make better decisions.

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1. Break-Even Analysis: How Much Do You Need to Sell to Cover Costs?

Scenario: A Bakery Trying to Stay Profitable

Imagine you own a small bakery that makes and sells custom cakes. You have the following expenses:

• Fixed costs (Rent, Salaries, Electricity, Equipment Maintenance): ₹3,00,000 per month
• Variable cost per cake (Flour, Sugar, Decorations, Electricity per unit): ₹400
• Selling price per cake: ₹1,000

To find out how many cakes you need to sell just to cover all costs, we use the break-even formula:

So, the bakery must sell at least 500 cakes per month to avoid losses.

What Happens Next?

• If you sell 600 cakes, you start making profits.
• If you sell only 400 cakes, you suffer a loss.

Using marginal costing, you can determine the minimum sales target and adjust your strategy (promotions, discounts, bulk orders) to achieve it.

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2. Pricing Decisions: Should You Lower Prices to Attract More Customers?

Scenario: A Tech Startup Launching a Subscription Service

You are the founder of a tech startup that just launched a cloud storage service. You're debating two pricing options:

1. Premium Plan (₹5,000 per year) – Fewer customers but higher profit per sale.
2. Budget Plan (₹2,000 per year) – More customers but lower profit per sale.

Your variable cost per user (server maintenance, customer support, software updates) is ₹1,000.

Using Marginal Costing to Decide

• If you sell the Premium Plan at ₹5,000, your profit per user is ₹4,000 (₹5,000 - ₹1,000).
• If you sell the Budget Plan at ₹2,000, your profit per user is ₹1,000 (₹2,000 - ₹1,000).

Now, let's assume:

• With the Premium Plan, you expect 1,000 subscribers.
• With the Budget Plan, you expect 10,000 subscribers.

Total profits:

• Premium Plan: ₹4,000 × 1,000 = ₹40,00,000
• Budget Plan: ₹1,000 × 10,000 = ₹1,00,00,000

Even though each Budget Plan user contributes less profit per unit, the larger customer base results in higher overall profits.

What Happens Next?

The company chooses the Budget Plan strategy, similar to how Netflix, Amazon Prime, and Spotify price their services to attract a larger audience at a lower price point.

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3. Make or Buy Decision: Should You Manufacture In-House or Outsource?

Scenario: A Clothing Brand Expanding Production

A startup fashion brand makes custom jackets. Now, they are growing and must decide:

1. Manufacture jackets in-house → Cost per jacket: ₹1,800 (materials, labor).
2. Outsource to a factory → Cost per jacket: ₹1,500 (factory charges).

At first glance, outsourcing seems cheaper. But marginal costing looks beyond just cost per unit and considers:

• In-house production allows better quality control and customization.
• Outsourcing allows faster production and higher volume sales.

Using Marginal Costing to Decide

If producing in-house results in higher-quality jackets that can sell for ₹3,500 instead of ₹3,000, it might be worth the extra cost.

Final Decision:
The company outsources basic jacket production while keeping premium designs in-house, allowing both cost savings and brand uniqueness.

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4. Accepting Special Orders: Should You Accept a Discounted Bulk Order?

Scenario: A Restaurant Receives a Corporate Catering Request

You run a high-end restaurant where a meal costs ₹1,500 per plate, and variable costs (ingredients, cooking) are ₹600 per plate.

A corporate client requests 200 meals at ₹900 per plate—far lower than your usual price. Should you accept?

Using Marginal Costing to Decide

• Even at ₹900 per plate, the restaurant still makes a profit of ₹300 per meal (₹900 - ₹600).
• Since the fixed costs (rent, salaries) won't increase, the order brings in extra profit of ₹60,000 (₹300 × 200 meals).

Final Decision:

The restaurant accepts the order because even at a lower price, it contributes additional profit without affecting regular business.

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5. Product Mix Decisions: Which Products Should You Focus On?

Scenario: A Supermarket Optimizing Shelf Space

A supermarket sells two types of coffee:

• Premium Organic Coffee: Profit per unit = ₹150
• Regular Coffee: Profit per unit = ₹20

Even though regular coffee sells in higher volume, premium coffee generates more profit per unit.

Using Marginal Costing to Decide

• The store reduces stock of regular coffee and increases marketing for premium coffee.
• Customers switch to premium coffee, leading to higher overall profits.

Final Decision:

By focusing on high-margin products, the supermarket earns more without increasing sales volume.

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6. Shutdown or Continue: Should a Business Close During a Slow Season?

Scenario: A Gym Facing a Summer Membership Drop

A gym experiences a drop in memberships every summer. Fixed costs (rent, staff salaries) remain the same, but member fees decline.

Instead of shutting down, they:

• Offer summer discounts to attract new members.
• Introduce seasonal yoga and fitness programs to increase sign-ups.

Using Marginal Costing to Decide

• Even if memberships are lower, covering some costs is better than covering none.
• The business remains open, reduces losses, and retains customers for peak season.

Final Decision:

Instead of closing temporarily, the gym adjusts pricing and services to remain profitable.

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Conclusion: Why Marginal Costing is Essential for Business Success

Marginal costing is not just a theoretical concept—it’s a powerful decision-making tool that businesses use every day.

It helps businesses:
✅ Set the right selling price
✅ Determine the break-even point
✅ Decide whether to make or outsource
✅ Choose whether to accept special orders
✅ Identify the most profitable products
✅ Make survival decisions during tough times

By applying marginal costing principles, companies make smarter choices, increase profitability, and stay competitive in the market.