Product Costs Definition
Define product costs as the total costs of creating products, is an essential factor in the success of a manufacturing business. Some of these components include all direct costs, from raw materials to labor and even transportation, included in creating a finished product ready for sale.
Product Cost Explanation
Explain product cost as the entire cost spectrum for a product, can have varying levels of complexity. The product cost concept will vary greatly depending on the type of product produced.
For a simple injection-molded plastic product, product cost per unit will include raw plastics, transportation from the raw material maker to the manufacturing plant, labor, energy used by manufacturing machines, and more.
For a software product maker, a product cost breakdown will include development labor, energy, and any other costs directly associated with making the piece of software.
Any business which makes products has a product cost. To assure efficient and profitable systems it is in the best interest of the business owner to monitor these costs. From this information a company can solve internal problems and ultimately increase the company’s bottom line (Revenue – Costs = Profit).
Product Costs Formula
No single product cost formula seems to exist. More, it is the combination of all of the costs which add up to create a product. This can widely vary based on industry, production method, and more.
An industry average may be available to perform product cost analysis as compared to standard practices. This way, a company can see if they are meeting common standards. From here a company can attempt to become more efficient than the industry standard by enacting some best practices.
Product Cost Example
Sterling is the owner of a web development company. Though he works with intangible assets, mostly, he still has a product cost equation. His product cost effects his bottom line as much as any manufacturing firm.
On average, Sterling charges clients $10,000 for a perfect web application which is ready to be deployed. In comparison, it usually costs him about $3,000 to create one of these applications. Sterling would like to reduce this in order to increase company profits.
Sterling looks at his main factor: labor. By hiring better developers Sterling will slightly increase labor costs but also expects the developer to produce 10% more in one hour than his current employees.
On the other hand, by purchasing new development software Sterling expects to also increase average worker productivity by 10%.
Choosing An Option
In this example, Sterling will choose an option based on his preferences. Rather than interviewing an entire new team he opts for the new system. This way he will not have to waste time, energy, and create a hassle for his current employees. He chooses this option after speaking with his CFO, who informs him that the cost of the new system will be virtually the same as the cost of hiring new employees. Specifically, the software will cost a total of $160,000. He will have to spend $159,500 on project manager time, new employee training, and processing.
Sterling is confident that he has made the right decision. He looks forward to his new software and the happy faces of the employees he appreciates.
To learn how to price for profit, download our Pricing for Profit Inspection Guide.
[box]Strategic CFO Lab Member Extra
Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs[/box]