Making a profit selling products is the foundation of any successful ecommerce business. But it isn’t always as simple as it sounds.
Let’s take a hypothetical sporting goods company: If it costs them $20 to produce a pair of ice skates, they can price them accordingly to earn a profit.
But what if their competitor can produce a similar pair of ice skates for only $15? That brand can undercut them on price, as fewer customers are likely to buy the more expensive skates. This is where cost per unit becomes critical.
In this article, we’ll break down how much it costs to produce a single item, and how to reduce it through different strategies, including streamlined logistic operations such as network optimization.
Definition and Importance of Cost Per Unit
Cost per unit is a fundamental logistics KPI used in accounting and managerial economics. It refers to the average cost incurred for each unit of product manufactured or service delivered.
It is a crucial measure for a business’s profitability and analytical capabilities. Informed businesses know how to calculate the cost per unit for each product or service offered to make informed pricing and marketing decisions.
The Role of Cost Per Unit in Business Operations
Cost per unit plays a crucial role in day-to-day business operations as it helps determine optimal selling price, gross profit margins, and profitability metrics. Moreover, monitoring the cost per unit over time provides valuable insights into trends and allows for a real-time analysis of expenses and revenue.
Additionally, the unit cost is influenced by multiple factors, such as fixed, variable, direct, indirect costs, production volume, and more.
Understanding the Components of Cost Per Unit
To understand the cost per unit formula, it is necessary to know its two components: fixed costs and variable costs.
Fixed Costs: Definition and Examples
Fixed costs are the expenses that remain constant regardless of the level of production or sales volume. Rent, insurance, salaries, and interest payments are examples of fixed costs. For example, if a company rents a warehouse, the rent doesn’t go up or down if they produce 100 pairs of ice skates or 1,000.
Variable Costs: Definition and Examples
Variable costs, on the other hand, are expenses that change as production or sales increase. Direct materials, labor, and shipping costs are examples of variable costs. An easy example of this metric would be the price of leather for a skate manufacturer. As production increases from 100 to 1,000 pairs, the total cost of leather rises accordingly.
Breaking Down the Cost Per Unit Formula
Now that fixed cost and variable cost are explained, it’s time to look at how the unit cost is determined using these components. The cost per unit formula is simple: total production costs divided by the number of units produced.
Cost per Unit = Total Production Costs / Number of Units Produced
The total production cost is found by adding up the total fixed cost and the total variable cost. This formula can be utilized to find the cost per unit for any given product.
Practical Example of Cost Per Unit Calculation
Suppose a business produces 1,000 pairs of ice skates for a total production cost of $20,000. Dividing the total production cost by the number of units produced provides a cost per unit of $20 per unit.
The Difference Between Cost Per Unit and Price Per Unit
Cost per unit is different from price per unit, and understanding the difference is essential for calculating profitability.
Defining Price Per Unit
Price per unit refers to the price at which a brand sells its products or services, whereas cost per unit refers to the average expense incurred to produce a single unit of a product or service.
Pricing reflects both the cost per unit and the profit margin, and setting the right price for finished goods and services is crucial to maintaining profitability.
The Relationship Between Cost Per Unit and Price Per Unit
Understanding the relationship between cost per unit and price per unit is essential for maximizing profitability. Businesses should set a price per unit based on the cost per unit and the desired profit margin.
For example, if a brand can produce a pair of ice skates for $20 and wants a profit margin of 20%, it would need to sell each pair of ice skates for at least $24.
How to Use Cost Per Unit for Better Business Decisions
Understanding cost per unit can help brands make better-informed decisions. Here are some ways cost per unit can assist with better decision-making:
Setting the Right Selling Price
By analyzing the cost per unit and gross margin, businesses can set the optimal selling price for each product they offer. A thorough understanding of the cost per unit can help determine how much businesses should charge for their products or services to enable efficient operations and maximize profits.
Evaluating Business Efficiency
Monitoring the cost per unit over time can help businesses evaluate their efficiency levels. This analysis is essential in identifying where cost savings can occur and monitoring the impact of efficiency improvements in business operations.
Strategies to Reduce Cost Per Unit
Optimizing cost per unit requires a proactive approach to reduce costs without negatively impacting product quality. Here are some strategies businesses can leverage:
Optimizing Logistic Strategy
Streamlining logistics operations, reducing inventory holding costs, and minimizing time to market can all help reduce the cost per unit.
For example, streamlining logistics operations helps reduce the cost per unit by decreasing the amount of time and money it takes to get products to the customer. You can use tools like Flowspace’s Network Optimization System (NOS) to distribute your inventory across multiple fulfillment centers, shortening delivery times and lowering shipping costs.
Meanwhile, reducing inventory holding costs can be done by optimizing inventory levels and selling off excess inventory, while minimizing time to market expedites how quickly products go from development to sale.
Lowering Material Costs
By exploring alternative materials, reducing scrap and waste, and negotiating better pricing with their suppliers, brands can lower material costs and reduce cost per unit.
Reducing Overhead Costs
Overhead expenses such as rent, utilities, and salaries can all be reduced by implementing efficient business management processes and proactive cost-cutting measures.
Minimizing Returns, Reshipments, and Dead Stock
Minimizing returns, reshipments, and dead stock can all help reduce cost per unit. Returns can be costly for businesses, as they often involve shipping the product back to the manufacturer or retailer, inspecting it, and then reselling it or destroying it.
Reshipments can also be costly, as they involve shipping the product to the customer again after it was initially returned. Meanwhile, dead stock is expensive because businesses have to pay for the cost of storing it, as well as the cost of eventually disposing of it.
The Role of Warehousing in Cost Per Unit
Efficient warehousing plays a critical role in reducing the cost per unit and streamlining logistics operations.
How Efficient Warehousing Can Lower Cost Per Unit
Effective inventory management techniques such as proper demand forecasting, Just-In-Time (JIT) inventory management, and RFID technology can all help lower the cost per unit.
For example, by maintaining inventory accuracy and forecasting demand, brands can ensure that they have the right amount of inventory on hand to meet customer needs. RFID technology can also be used to track inventory movements in real time, which helps teams optimize their inventory levels and avoid stockouts.
The Impact of Warehousing on Fixed and Variable Costs
Effective warehousing can additionally impact both fixed and variable costs. Reducing fixed costs, such as rent and utilities, lowers warehousing expenses. Meanwhile, optimizing logistics operations decreases variable costs such as labor and material costs.
How Flowspace Helps Reduce Your Cost Per Unit
Partnering with a fulfillment provider like Flowspace is an efficient, seamless way to cut costs and boost operations.
Our order fulfillment platform effortlessly integrates with ecommerce platforms and various sales avenues. Meanwhile, an advanced product inventory management system gives brands real-time visibility and control, with alerts for low stock and data-driven tools to improve decision-making. This helps prevent stockouts, reduce excess inventory, and keep costs down.
Flowspace also leverages its Network Optimization System to intelligently route orders and position inventory across the ideal fulfillment centers.
As a result, you can ship from the closest location, cut down on last-mile delivery costs, and improve delivery speed.
Reach out now to discover how Flowspace can assist you in refining your inventory control and fulfillment strategy.
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