Page 121 - Marketing the Basics 2nd

price 113
are do not vary, regardless of the level of production. The sum of variable and fixed costs is called the total cost.
For companies that produce a handful of goods, speaking solely in terms of fixed, variable and total costs is sufficient. However, for those firms that sell millions of units, the importance of maxi- mizing scale economies is paramount since a small increase in efficiency has a large effect in magnitude on revenue. Therefore, calculating the average unit cost is needed to determine the right price. Average unit cost is calculated by the level of output divided by the total cost.
The price charged to consumers for a product must cover the total cost at a given level of production and return a profit to the firm, otherwise the company is losing money on each item it is producing – a quick entry strategy into bankruptcy.
There are two other costs a firm must take into account when making a pricing decision: sunk costs and opportunity costs. A sunk cost is one that the firm already incurred and cannot recover. Trying to recoup a sunk cost is ill advised because incorporating the additional cost of a past mistake inflates the average cost per unit. With a high average cost, the firm will require a higher rate of return on its investment. Those forgone investments are called the opportunity cost. When mistakes are made, it is better to write off sunk costs instead of making more investments to try to make the idea work.
STEP 4. ACTIVITY-BASED COSTING (ABC)
Having now established some of the costs a firm must be aware of, measuring costs accurately is extremely important. One system popular with companies that conduct lots of transactions with different suppliers is called activity-based costing, or ABC. This technique identifies the relationship between an activity and the resources needed to complete it. It then assigns costs to the resources consumed by the activity. Using ABC is advantageous because it tries to account for all the resources used in a company to serve a customer: production, resource acquisition, administrative fees and others. This allows the company to accurately gauge how much of their resources are consumed serving a customer.