What sets the foundation of any successful e-commerce business? Development of profit selling products indeed. But it’s not as simple as it sounds. Businesses have to monitor a key metric throughout their lifetime, i.e., net profit. It refers to the numerical value obtained after subtracting total cost from total revenue. Analysis of expenses and revenues gives a better overview of the company’s gains and losses.
However, certain strategies can help businesses increase their net profit. One of the most important ones is the decrease in cost per unit.
Wondering what it is and how it’s calculated? Dive into this comprehensive guide to find out! In it, we have overviewed all the essential aspects of cost per unit, its importance, and optimization. So, without any further ado, let’s begin exploring!
Part 1. What Is the Cost Per Unit?
It refers to the sum of all expenses a business has invested in the production, storage, and selling of a single unit of a product or a service. You may call it the cost of goods sold (COGS). Generally,It is divided into two branches: fixed costs and variable costs. Together, both determine the cost per unit of any product.
Part 2. Cost Per Unit Formula
It involves the sum of variable and fixed costs divided by the total number of units manufactured during a certain period of time. Here’s the formula:
Cost Per Unit = (Total Fixed Costs + Total Variable Costs) / Total Units Produced
For accurate calculation, one must understand the total fixed and variable costs. Here’s an overview:
Total Fixed Costs
These involve costs that remain the same no matter the amount of production. For instance, insurance, rent, capital equipment, etc. No matter how many units you produce, these costs will remain the same.
Total fixed cost = Building rent + Direct labor costs + Other fixed costs
Total Variable Costs
These costs differ based on the number of units produced. For instance, direct labor and direct materials. We can reduce these costs by either outsourcing products from an efficient manufacturer or hiring the cheapest labor. Other examples include packaging and shipping costs.
Total variable cost = Direct materials costs + Direct labor cost + Packaging costs + Shipping costs + Other variable costs
Cost Per Unit Example
Imagine we have company A, which developed 100 units of its product in the last month. The total fixed cost per month, including salaries, rent, etc., is $500. However, the variable cost in the last month was $300, which includes labor, electricity, and raw materials.
According to the formula:
Cost per unit = ($500 + $300) / 100 = $8
Thus, the cost per unit of their product is $8 for the last month.
Part 3. Cost Per Unit vs Price Per Unit
Note that the cost per unit is very different from the price per unit. Understanding this difference is crucial for calculating profitability.
Price per unit refers to the market price at which a business sells its products or services. Cost per unit refers to the sum of all the expenses incurred in the production, selling, and shipping of a single unit of a product or service. Businesses set price per unit based on cost per unit and desired profit margin percentage. Let’s continue with the last example.
In the last example, the product’s cost per unit was evaluated at $8. Now, if company A wants to obtain a 20% profit margin, it must set its products’ selling price accordingly.
Selling price = Cost per unit + Profit percentage
Selling price = $8 + (20% of $8) = $9.6
So, company A must sell its products at $9.6 each in order to obtain the desired profit margin.
Part 4. Why Cost Per Unit is Important for Business?
By now, you have obtained basic knowledge of the cost per unit. Let’s now determine why it is important for any business wanting to maximize its profit. It give the basics of the relationship between gross profit, logistics costs, and production costs. This can prove helpful in the development of a pricing strategy after evaluation of the raw material costs, manufacturing costs, marketing and sales costs, warehousing and storage costs, and fulfillment and shipping costs. But that’s not all!
Determines the Efficiency of a Business
It gives a detailed overview of the different costs involved in a product’s lifeline, from purchasing materials to production, packaging, shipping, and more. With this intricate breakdown, it becomes easier to identify the system inefficiencies that are increasing cost per unit. On the other hand, a lower cit symbolizes efficient production and increased profit chances. Thus, by carefully analyzing different expenditures, you can minimize loopholes and get your business on the right track.
Helps in Accurate Pricing of SKUs
Cost per unit also enables businesses to accurately price their products in order to obtain the desired profit. However, you must consistently evaluate cost per unit after certain periods, as variable costs fluctuate significantly. Also, understand the role of volume, as higher volumes and economies of scale come with impressive discounts to reduce cost per unit. Thus, the goal of any business must be to achieve the minimum possible cost per unit when maintaining sustainability and quality.
Part 5. How to Reduce Cost Per Unit?
Following are some effective strategies to reduce cost per unit without compromising on quality:
Minimize Raw Material Expenses
There are multiple ways to reduce material costs. Some of them include finding local suppliers, spotting lower-cost manufacturers, and optimizing product sourcing, eventually reducing cost per unit. Moreover, most wholesale suppliers have minimum order requirements, which must be met to source material at relatively lower prices. You can benefit from them by employing the strategy of obtaining greater volume discounts when reducing the average unit cost.
Reduce Holding Costs
Holding costs refer to the expenses incurred in storing unsold inventory. These costs involve labor, warehousing, opportunity costs, etc. Most companies increase their inventory costs by overpaying for storage they don’t even need. You can significantly reduce such costs by implementing an inventory management system via warehouse slotting or partnering with a 3PL service.
Minimize Reshipments and Cancellations
Another important aspect is to minimize reshipments and cancellations. Most reshipments and cancellations occur due to shipment delays. These can be due to discrepancies between the actual sizes and weights. So, double-check everything and review each product’s weight and size before sending it over to the shipping service. The best way here is to partner with a 3PL service to minimize all such delays, as these services are responsible for the entire order fulfillment process, saving a lot of hassle and loads of money.
Eliminate Waste
Waste elimination can also help increase efficiency and minimize production costs. One key area of waste production is human error or inefficient processes that end up with loads of scrap. But wait, by waste, we don’t only mean material waste. We also mean the waste of time and skills. For instance, your business might experience labor waste when it is waiting. Other cases involve time wastage due to non-value-added steps, like manual inspection.
Save Fulfillment Costs with NextSmartShip
Are your logistics making up a significant part of your cost per unit, or are you facing difficulty managing your inventory? NextSmartShip is here to save the day! Not only will they deliver your orders safely, but everything from receiving orders to processing them and managing inventory will be their responsibility. The best part? This logistics company excels in offering the best service at reasonable pricing, specifically benefiting small businesses.
Moreover, they have integrated advanced technologies for seamless order fulfillment. Your customers can obtain real-time tracking updates, and you can obtain real-time inventory updates. So, why skip luxury when it’s obtainable at reasonable pricing and even help you reduce cost per unit?
Conclusion
Cost per unit is indeed an important aspect to consider when deciding on certain business matters. For instance, estimating price per unit, figuring out production inefficiencies, and deciding whether a product’s production is valuable or not. The market price of a product is based on its cost per unit and the profit made from each unit. It must be balanced so that the business is still in the race to offer competitive pricing.
You can optimize your overall production, packaging, and shipment process to reduce cost per unit and achieve greater profit or an edge over your competitors at lower market prices. NextSmartShip can also prove helpful here, as it promises budget-friendly 3PL services for businesses. Visit their website for more details regarding the services they offer and get a quote, too! Hope you found this info worth reading. Stay tuned for more of such informative guides.
