Business Applications: Know your costs

What does it cost you to provide the revenue generating service or product upon which you and your employees depend for a living and your customers depend for value?  Can you break down that cost into individual parts and determine if, in fact, you are getting the best value for your investment?

While it is likely these questions are of interest to you they are rarely easy questions to answer.  There are some industries though, where if you answer them correctly you can devastate the competition.  These are likely industries where one or more of your raw materials are in short supply and variable in quality and therefore value.  If you can capture the highest value product by paying a little more, then create the finished product for the same or less than your competition then your product can be higher quality at the same or lower cost.  Your competitive edge then is being the preferred customer of the raw material because you can pay more AND the preferred vendor of the finished product because you are the higher quality at the same or lower cost.  How can you achieve this?  By tackling that difficult problem of knowing your input costs through the entire product or service creation better than anyone you compete against. Once you know your costs and how to minimize them, it is also critical that the behaviors that minimize cost through the organization be easily and reliably replicated.

This is where a custom application can provide a big advantage over standard software.  If you use the same software that your competitor does then your competitor has the same opportunities to achieve the cost reductions.  You are limited in your tactics to methods that the standard software will support.  Your advantage is limited to being able to use the standard software better than your competitor.  The barrier to entry, should you succeed, is much lower because once your competitor sees your success they have the tools in hand to replicate that success, they just have to use it.

Custom software, on the other hand, is tailored exactly to your knowledge of your business.  The more information you can input into your software and manipulate the better and more granular your cost knowledge becomes.  When it is clear that doing something differently will make your costs go down or your quality or yield go up then changing the software to behave in that new way should be easier.  More importantly if you find a method that would not be supportable with the standard piece of software you are increasing the barrier to entry for your competition.

A company I worked with several years ago made their living buying a manufactured product that had seen better days (used) and selling pieces of that product in order to make a profit.  There were dozens of ways the product could be resold, whole for salvage, partial for salvage, pieces for reuse, pieces for specific salvage, and many others.  Each type of disposition had it’s own costs.  As a quick example:

  • Sale as a whole salvage item
  • – $100 = Whole Item Cost
  • – $  25 = Labor to process from intake to sale as salvage
  • +$150 = Whole Item Value Salvage
  • =$  25 Profit
  • Single part separation
  • +$  75 Single part value separated from the whole
  • – $  50 Labor to separate single part
  • – $  10 Salvage value decrease of remaining whole
  • – $  15 Inventory holding costs (space, time value of money, etc.) for single high value part

Separating the part from the whole becomes at best a break even. But, if you know your costs this accurately, and you can shave $20 off the three costs of breaking out the single part, now you can pay an extra $10 for the supply. Your competitor can not pay that much, or if they do they are paying too much. With overhead they could begin to loose money on every purchase. You either corner the market and make better profit on each of this particular item or you force your competitor to loose money which, over time, will kill them. Multiply this over hundreds of items which all could be separated in multiple ways and you can see that the modeling and management could be come extreme unless you had the proper tools.

While it is still a daunting task to get all the costs itemized, the potential value, especially if you can tightly control this information as a trade secret, is large. By creating a custom application and allowing only a few trusted employees to enter the key values under the proper protection agreements you can create a system that gives you a large competitive advantage AND a huge barrier to entry. The rules of the system are “under the covers” so even the employees who are working closely with the inputs and outputs and modifying the systems values still only see a “black box” when it comes to the rules. These employees might be able to do the same things in spreadsheets at a much lower cost but this makes it much harder to maintain the trade secrecy value of the information and the business far more dependent on that particular individual.

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