Companies that operate in a market economy generally strive to generate a profit with their products and services. A profit situation occurs when the sum of the sales proceeds is higher than the sum of the variable unit costs and the fixed costs. The point at which at least the variable unit costs are covered is called the operating minimum.
Definition / explanation
In the operational cost function, the operational minimum is shown as the intersection of the marginal costs with the curve of the variable average costs. If the sales revenue corresponds exactly to the operating minimum, no contribution is made to offset the fixed costs. Proceeds of this magnitude can only be accepted for a short period of time. That is why business economists speak of a “short-term lower price limit” in this context.
If there is no prospect of higher sales prices in the future and all options for cost optimization in production have already been exhausted, losses will arise with each piece produced that are higher than if production was stopped. A continuation of the work in the relevant field of activity would no longer make sense under these conditions.
Operating minimum as a strategy
For reasons of market strategy, companies sometimes accept to reduce their prices to the operating minimum for a short time or even to fall below this. Such a strategy can be useful, among other things, if it succeeds in reducing the market share of a competitor or pushing him out of the market altogether and thereby attaining a monopoly position (see monopoly and Pricing strategies).
The short-term losses that resulted from cutthroat competition are offset again by positive follow-up effects in the later course of the year. The same applies to the market launch of new products or to bridging short-term demand bottlenecks.
How long a company is willing or able to accept such a situation depends above all on its financial resources, as it has to cover the fixed costs that are not covered by the sales proceeds on its own.