What is Marginal Profit?

Marginal profit is the difference between the marginal revenue and marginal cost associated with a sale transaction. Thus, it is the incremental profit gained from generating one additional sale. Generally, a business should continue producing units as long as there is a marginal profit to be gained from each additional sale. As a business reaches the upper end of its available production capacity, it becomes more expensive to produce goods, since maintenance and overtime costs increase; this increase in costs typically minimizes the additional incremental sales volume that can be achieved.

A key management decision is whether to increase capacity when all available production volume has been used up; a key part of this decision is the amount of marginal profit expected to be earned from the additional capacity.

Example of Marginal Profit

Inscrutable Corporation’s managers are trying to decide whether to sell one additional unit of its Inscrutable Software, which is used to automate the interactions of its customers with their clients. A major customer wants to increase its seat license by one more seat, and is offering to do so at an incremental cost of $100. Inscrutable normally charges $1,000 for each incremental seat. In this case, the company incurs only $10 to record the extra seat license in its records - otherwise, there is no incremental cost associated with the proposed deal, so Inscrutable would generate a marginal profit of $90.

While this example shows that the seller will generate a marginal profit at almost any price point, a major concern is whether allowing such low pricing will damage the customer’s perception of what they are receiving. From a brand management perspective, it may make sense to keep the per-seat price relatively high.