Marginal cost is the added expense of producing one more unit of a product or service. It captures the added cost incurred when output increases so that businesses can answer a crucial question: Is it worth producing just a little more?
It is, if the cost to produce your 1,001st widget is $4, but you can sell it for $9.
In reality, though, the answer is rarely so clean-cut. In some scenarios, it’s not cost-efficient to produce more goods than originally forecasted.
Marginal cost includes variable costs (such as materials, labor, and utilities) but excludes fixed costs that remain constant regardless of output. For example, rent at your factory or warehousing facility remains constant, even if material costs drop or workers' hours are cut.
When increasing the number of units of a product or service, your fixed costs remain steady, but your marginal costs may rise. In one common scenario, a freight provider may not have the capacity to ship more goods. Or, adding additional providers to the mix introduces risk and logistical complexity, and could raise shipping costs by 11%.
Pricing, budgeting, and production all hinge on the understanding that selling more doesn’t automatically mean making more money. This helps manufacturers avoid overproduction while forecasting how each additional unit will impact profit margins.
Unlike cost averaging, which smooths total costs for an average across all goods, marginal costing provides more accurate and timely insight into the profitability of scaling up.
Marginal cost also plays a starring role in cost-volume-profit (CVP) analysis, helping finance leaders determine break-even points and optimal production thresholds.
The marginal cost formula is a simple calculation that yields powerful results:
Marginal Cost = Change in Total Cost ÷ Change in Quantity Produced
Here’s a hypothetical scenario:
You now know the cost to fulfill additional customer demand and can determine whether or not it’s worth it for a $15 increase in price per unit.
Across different industries, different expenses factor into marginal cost:
Tools like Epicor Financials (accounting), Epicor FP&A (reporting and scenario planning), and Epicor IP&O (inventory planning) make it easier to automate marginal cost tracking—especially when production inputs and customer demand shift rapidly. Constant real-time data supports more accurate forecasting, pricing models, and profitability analysis.
→ Looking to automate marginal cost tracking across your operations? See how Epicor Financials makes it easier.
Understanding marginal cost is a strategic growth lever. Used strategically, marginal cost analysis can help companies price more competitively, plan production more efficiently, and optimize profits in real-time.
Companies often use marginal cost pricing to enter new markets or clear excess inventory. For instance, if your marginal cost is $5 per unit and you’re entering a price-sensitive market, setting a price of $6 or $7 might still deliver positive margins—while beating out competitors and increasing market share.
Marginal cost is also a key input in dynamic pricing models. Businesses with digital storefronts or logistics-heavy operations can track how marginal costs change with variables like fuel, materials, or storage fees. That enables them to adjust prices quickly to remain profitable.
Marginal cost also helps CFOs and FP&A teams prioritize where to allocate resources. If the marginal cost of producing more units falls due to scale (and volume discounts), ramping up production may drive stronger returns.
On the flip side, rising marginal costs can signal operational inefficiencies or supply chain issues—data your finance team can act on.
ERP systems like Epicor Kinetic provide real-time insights into marginal costs by pulling live data from across procurement, production, and inventory. This enables faster decision-making and greater precision, especially when demand spikes unexpectedly.
→ Want to turn marginal cost insights into smarter business moves? Explore Epicor Kinetic for real-time production and cost data.
Marginal cost doesn’t behave the same in every scenario. Understanding when and how it changes can help teams make smart choices for the financial health of their business.
Short-run vs. long-run: In the short run, some costs are fixed (like rent or salaried labor), so marginal cost mainly includes variable expenses. In the long run, more costs become flexible, allowing companies to restructure operations to lower marginal costs overall.
Economies of scale: As output grows, marginal cost typically declines—at least until capacity constraints, labor shortages, or supply chain disruptions cause costs to rise again. This U-shaped curve is critical in manufacturing and logistics.
Industry examples:
This variability shows the importance of scenario modeling. The more your finance teams can simulate marginal costs under different assumptions, the more accurately it can guide decisions about pricing, fulfillment, and capital investment.
Marginal cost and average cost are closely related, but they’re not the same thing:
Marginal cost tells you if producing one more is worth it. Average cost tells you how efficiently you're producing items overall.
Here’s a hypothetical scenario using USB-C to USB-C cords:
A manufacturer produces these cords and sells them to retailers at a per-unit price of $3.00, who then sell them to consumers for $7.00.
Let’s say the average cost to produce 5,000 cords is $2.50 per unit. However, the marginal cost to produce each of the final 1,000 units (beyond the first 4,000) is $3.00 per cord. In this example, we’re assuming marginal cost is constant across those 1,000 additional units.
Looking at the average cost, producing 5,000 units appears profitable, with an overall 16.7% profit margin ($0.50 profit on each $3.00 unit).
A closer look shows that only the first 4,000 units are actually profitable. Those can be produced at an average cost of $2.38 per unit, yielding a profit margin of roughly 21%.
Beyond 4,000 units, the manufacturer is no longer making a profit. Each additional cord costs $3.00 to produce and sells for $3.00, meaning they’re just breaking even. That leaves no cushion if variable costs increase. Even a $0.01 rise in cost would result in a loss on every additional unit.
Costs could rise after 4,000 units due to overtime labor, higher material prices, or exceeding equipment capacity. That’s why 4,000 units is the optimal scale; production beyond that figure leads to inefficiencies.
Still, understanding both average cost and marginal cost is essential for financial modeling and cost control. CFOs and controllers will closely track average costs to spot baseline trends while using marginal costs to optimize production decisions in real time. Systems like Epicor EPR give businesses continual insight into unit-level production and sales.
Although understanding marginal costs is powerful, the method does have its blind spots.
Not all costs scale smoothly. Overhead allocation, labor variability, and maintenance costs may not rise or fall in predictable ways, especially in the service sector or project-based businesses.
The method doesn’t account for value perception. Marginal cost doesn’t consider what customers are willing to pay. That’s why pricing solely on marginal cost can leave money on the table.
Marginal cost analysis assumes linear scenarios every time. Real-world conditions are rarely linear. Market shocks, supply chain disruptions, or shifts in demand can quickly distort marginal cost assumptions.
Marginal cost is just one piece of the financial puzzle. For a more complete picture, companies should pair marginal cost analysis with other calculations:
The right ERP tools can combine these perspectives into dashboards and visuals for a complete view, helping leaders make informed choices.
→ Ready to make marginal cost work for your business? Talk to an Epicor expert today.
