The Hindu Business Line : Costs, costs everywhere

In an earlier article in this series, we said that the cost of anything is defined by the purpose for collecting or reckoning the cost. In other words, there is no such thing as the cost - it all depends! This is not just a typical academic inability to make up one's mind, but reflects a fundamental truth about business. All business activity is only for enhancing somebody's value, hoping all the time that it does not actually destroy anybody else's. Therefore the cost can only be a perception, just as the benefit is, however much one might feel that there is an actual amount for which one's bank account is debited when one acquires a product or service. But thereby hangs a tale. What you write the cheque for is the price often confused with the cost! In some circumstances the two might be the same.

Managers need to be familiar with some minimum accounting terms when it comes to costing. Here are a few. Opportunity cost is a conceptual cost. It is the cost of the lost opportunity. If I give away a few lakhs of Rupees towards my children's education instead of applying for an educational loan, one might say I have foregone the interest I would have earned instead, say 7 per cent, by keeping it in the bank. On the other hand it is possible to argue that it might not be such a good idea to borrow at a higher rate of interest, let's say 10 per cent. But wait a minute; what happens if the repayments start only after the education is complete? One gains a couple of years during which the actual value of the borrowed amount might decline — in fact will certainly by around 10 per cent in two years, under Indian conditions. Now is it better to borrow or spend from savings? Again, the dreaded words `it all depends'. If there is a prospect of your earning a still higher return soon, then to that extent there is an opportunity cost i.e. return foregone.

Marginal costs are often the bugbear of line managers. Many a proposal seems attractive if one looks at the marginal costs alone i.e. those that will vary or have to be incurred with each additional unit produced and sold, but not so if one imputes all the overheads to the product in question. Accountants secretly wish, I am sure, that the idea of marginal or incremental costing had never been taught to functional managers because they tend to run away with the notion to justify almost any short term expenditure for revenue increase, especially in marketing. Unfortunately, in the competitive world, one has to be content with a contribution rather than a full profit as planned. This is often used to justify promotional efforts aimed at meeting sudden downturns or upsets in the marketplace.

Zero-based costing is yet another new way of looking at a decision such as an annual budget for R&D or administration. It asks one to justify every step one plans to take in the language of value analysis: Is this really essential? Can it be done simpler, cheaper, faster? That is to say, start with a clean, empty slate (hence zero base), don't assume that 10 per cent increase over what you spent on an item last year would be automatically assumed to be all right.

Not to be outdone by the accountants, marketing people too have devised a powerful new costing concept, from the customer's angle. Lifetime or lifecycle cost estimates the full cost of acquiring and using a product, typically an equipment, machinery or appliance. This includes costs of running, repairs, maintenance and fuel power or whatever is applicable. Owners of vehicles will straightaway see that there are some cars and motorcycles that are truly more efficient and intelligent buys in the long run because they hardly need any repairs or upkeep and are rugged enough to withstand rough or beginner's use. If such a vehicle is a bit more expensive, say 5 to 10 per cent on the showroom price, a smart user makes a quick mental calculation and decides in favour of a better brand, despite a premium. After all, most of us want a hassle-free world and the least we can hope for from our possessions is not to add to our daily dose of worries. The long-term or lifetime use cost (as opposed to just price) is a great argument in the hands of good salespeople. You can also throw in where relevant a resale value, upgrades, switching costs, training costs and many others to embellish the argument and show how a seemingly higher priced brand is in fact logically the better buy!

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