Sometimes two or more products result from a common raw material or production process; these products are called joint products. Companies can process these products further or sell them in their current condition. For instance, when Chevron refines crude oil, it produces a wide variety of fuels, solvents, lubricants, and residual petrochemicals.

Management can use differential analysis to decide whether to process a joint product further or to sell it in its present condition. Joint costs are those costs incurred up to the point where the joint products split off from each other. These costs are sunk costs and are not considered when deciding whether to process a joint product further before selling it or to sell it in its condition at the split-off point.

The following example illustrates the issue of whether to process or sell joint products.

Coloure sells untinted enamel outdoor furniture paint in​ bulk, five-gallon containers to large home improvement stores. Each​ batch, processed at a cost of $840​, yields 300 gallons of paint. Coloure sells the​ five-gallon buckets for ​$140 ​each, and spends ​$1.40 for each plastic tub.

Coloure has recently begun to reconsider its strategy. Management has asked if it would be more profitable to sell​ quarts of paint to small boutique stores and commissioned a market analysis that indicates that demand for the repackaged product exists.

Coloure could further process each batch of paint into 1,200 quarts and would sell quarts for ​$9. Packaging would cost $1.0 per​ portion, and pigment would cost $0.50 per portion. Fixed costs would not change.

Using a differential analysis, we would find that further processing (ignoring any additional capital expenditures) would yield $5,160 less per month in operating income (negative numbers are shown in red):

We can sell 600 five-gallon tubs for $160 to the big box-store retailers, who then mark it up to $200, or we can sell 12,000 quarts to smaller operations for $9, who then mark it up to $15. Gross sales to the box stores = 600 units * $160 = $96,000. Alternatively, gross sales to the boutique stores = 12,000 units * $9 = $108,000.

However, additional costs to process into quarts = $1.5 * 12,000 units = $18,000 and the company only saves $840 by not buying 600 five-gallon tubs. Therefore, by processing further, the company would lose $5,160.

Companies use this same form of differential analysis to decide whether they should discard their by-products or process them further. By-products are additional products resulting from the production of a main product and generally have a small market value compared to the main product. Sometimes companies consider by-products to be waste materials. For example, the bark from trees cut into lumber is a by-product of lumber production. Although a by-product, companies convert this bark into fuel or landscaping material. When the differential revenue of further processing exceeds the differential cost, firms should do further processing. As concerns increase about the effects of waste on the environment, companies find more and more waste materials that can be converted into by-products.

Here is a more detailed look at the decision-making process with regard to sell or process further:

You can view the transcript for “Sell or Process Further Decision” here (opens in new window).

Now check your understanding of how to decide when to sell a product and when to keep processing it further.