What is Unit Cost?

Unit cost is the outlay incurred to produce a single unit of a product or service. Since this outlay is typically comprised of both variable cost and fixed cost elements, the cost for a single unit is derived by compiling all costs of production and dividing by the number of units produced. Unit cost is one of the most commonly-tracked cost accounting measurements, since it indicates the ability of a business to earn a profit.

Example of Unit Cost

A small furniture company manufactures wooden chairs. For one month, the company incurs $5,000 in fixed costs (including rent, salaries, and equipment depreciation) and $15,000 in variable costs (including wood, screws, and direct labor) to produce 1,000 chairs. The total production cost is $5,000 + $15,000 = $20,000. To calculate the unit cost, the company divides the total cost by the number of units, as noted next:

$20,000 ÷ 1,000 chairs = $20 per chair

This means each chair costs $20 to produce, which helps the business set prices and evaluate profitability.

How to Reduce Unit Costs

A business that competes by being the lowest-cost producer will focus on reducing unit costs below the costs that can be achieved by its competitors. This can be done by employing any or all of the following methods:

Shifting production to a lower-cost country, to take advantage of lower labor costs.
Constantly looking for the lowest-cost suppliers, to reduce the cost of direct materials.
Using automation to reduce the amount of direct labor cost incurred.
Shifting facilities to low-tax locations, to reduce tax costs.
Purchasing competitors in order to expand production volumes to take advantage of the experience curve and purchase volume discounts.

By being in the lowest-cost position, a business can always set prices lower than its competitors while still earning a profit.