The calculation is one multiplication. Getting the inputs right is where the value is, and where most attempts go wrong.
The four inputs
Design rate at the constraint. Units per hour, established as we covered last week, using the lower of the nameplate and the best documented sustained rate.
Selling price per unit. From finance, for the product family that actually runs on this asset.
Variable cost per unit. Also from finance. Materials, packaging, and anything else that scales with volume.
Contribution margin per unit. Price less variable cost.
On our line: $26.00 less $16.00 is $10.00. At 600 bags per hour, one constraint hour is worth $6,000.
Why contribution margin and nothing else
This is the part that decides whether your number survives its first meeting.
Not revenue. Revenue includes the material you would have had to buy to make the extra units. Using it overstates the opportunity by a wide margin and invites an easy dismissal.
Not gross margin. Gross margin has fixed manufacturing overhead absorbed into it. But your fixed overhead does not change when the constraint runs an additional hour. You are already paying for the building, the salaried staff, the depreciation, and the utilities base whether the hour runs or not. Deducting that overhead again from a recovered hour charges you twice for cost you have already incurred.
Contribution margin. Price less the cost that actually varies with the unit. When the constraint produces an incremental hour of output, the full contribution margin drops through to EBITDA, because nothing in the fixed base moved.
That last sentence is the one to have ready. It is the reason a $6,000 hour is worth $6,000 to EBITDA and not some smaller figure after allocations.
How to run the finance conversation
Ask for one thing: price less variable cost per unit, for the product family that runs on this asset.
If the response is that it depends on mix, ask for a weighted average across the mix that actually runs on the line, or take the lowest margin product and use that. A conservative figure that finance provided is worth far more than an accurate figure you estimated yourself.
Get it in writing. An email is enough. What you are doing is converting your number from an opinion into a shared assumption, and a shared assumption is almost impossible to attack six weeks later when you present. The people who skip this step are the people who spend their funding meeting arguing about the denominator instead of the decision.
There is a secondary benefit that is worth as much as the number. Most reliability and operations leaders have never had a substantive conversation with finance about margin. This one is short, specific, and easy to say yes to, and it starts the working relationship the entire funding case depends on.
The framework this sits inside
Pricing the hour is step two of five.
- Name the hour. Identify the asset that sets the pace, because only its hours carry the full margin.
- Price the hour. Design rate times contribution margin.
- Count the missing hours. How many hours the asset did not run at rate.
- Buy the hours back. Rank actions by cost per hour recovered.
- Bank the hours. Prove the result reached the actuals, which is what gets the next one funded.
The framework does not change. Only the asset and the numbers do, which is why it keeps working on assets you have not met yet.
This week
Run the multiplication. Get the email from finance. Write one line: one hour on this asset is worth this many dollars.
