DJ Stockbridge is currently pursuing a Masters degree in Accounting.
Imagine you are the owner of a seafood restaurant in your hometown. The business has been very successful since its inception 20 years ago, but it's starting to have some difficulties. Two other seafood restaurants have started in town within the last two years. They have 'piggy-backed' on your success. They've even positioned themselves like you with special deals on certain days like 'Half off lobster Wednesdays' and 'All you can eat shrimp on Thursdays.' You want to cut down on your costs so the business will have more money to reinvest. More specifically, you want to cut down on avoidable costs.
This lesson will first define avoidable costs. Then you'll see examples of ways an owner can reduce expenses by targeting avoidable costs.
Avoidable Cost: Definition
An avoidable cost is a cost that is not incurred if the activity is not performed. Put another way, a company can avoid the cost if they no longer produce the good or service. For example, the cost of materials that go into a finished good is an avoidable cost. In order to not pay the cost, the business can simply stop producing the good or service. These costs are often identified as variable costs. They vary based on production. If there is no production, there is no cost.
As part of your review of your seafood restaurant you notice there are a few avoidable costs that you can eliminate. The first is that for the past few years you have served hamburgers, steaks, and other non-seafood entrees. These are expensive meals to prepare because you need to go through a different vendor than you do to source your seafood. And not to mention, only a few customers order non-seafood meals. If you decided to no longer offer these options the company could save a lot of money.
In fact, the total cost for you to serve these non-seafood dishes is $75 per night. There are fixed costs of $25 which include the cost of maintaining the restaurant, paying property taxes, depreciation on the kitchen equipment, etc. These costs cannot be avoided. The other costs, however, are avoidable. You know each pound of non-seafood costs you $10.00. Generally, each entrée has ½ lb of food, and you serve about 10 non-seafood entrees per night. That means your cost per night is $10.00/lb x 10 entrees x ½ lb = $50. If you decided to no longer offer these options, then the company would save the $50 each night.
Another avoidable cost is the expense of the bread which is served before a meal. You have always served bread, but you've noticed many people do not eat it, and those who do eat it regret it because they 'fill up on it' and are not able to enjoy their main meal as a result. Similar to the non-seafood entrees, you can decide to no longer offer the bread, and you'd save on the costs of buying the ingredients and paying the cooks to bake it.
Avoidable costs are those costs that can be avoided if the good or service is no longer produced. As the business owner, you have control over these costs, and because of this avoidable costs are often the first costs targeted in a cost reduction program. Avoidable costs are also referred to as variable costs; they include the cost of materials, packaging, direct labor, and other inputs into the production process.
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