Have you ever wondered or questioned why many people tend to choose the lowest cost options frequently ignoring the quality of what we consume or the effectiveness of services we receive? Even though the economic elite can afford and often prefer luxury goods, this question is pertinent given the middle and lower price ranges in the global market are dominant.
In both business and economics, the notion of cost-efficiency has always been central to decision-making, particularly in manufacturing processes. One of the most widely embraced measures in this context is the "lowest cost per unit of output". This metric reflects the direct relationship between the cost incurred in producing a good or service and the number of units generated. It is essentially the total cost of production divided by the quantity of output, revealing how much it costs to produce a single unit. There are several reasons why firms, individuals, and even governments strive to minimize the cost per unit of output. These reasons span from maximizing profitability, improving competitiveness to efficient resource utilization. Each rationale reveals how this principle drives modern production and resource allocation strategies and human behavior.
The use and analysis of "lowest cost per unit of output" as a universally desirable metric, which represents the total production cost divided by the quantity of output, though a valid academic exercise, should raise red flags in your mind. While this measure is widely used to assess production efficiency almost universally the inherent danger lies in its universal adoption in every sector of the global economy. Consider it this way: would you choose an airline to fly your family on vacation that has won the excellence award for "lowest cost per unit of output"? How about a network of hospitals in your hometown? And yet humanity remains intoxicated with the universal application of this economic model in all industries.
In other words, the metric 'lowest cost per unit of output,' defined as total production cost divided by output quantity, is widely regarded as a benchmark for production efficiency. However, its universal application as a sole measure of success can be misleading and even dangerous. To reiterate, consider an airline that excels in minimizing costs per passenger-mile—would this alone inspire confidence in its safety or quality of service? This example underscores the risk of prioritizing cost efficiency at the expense of other critical dimensions, such as quality, safety or sustainability.
While the metric has its place in economic modeling, reliance on it without considering context or broader implications may lead to undesirable outcomes in all industries and all sectors of the economy. Whenever management becomes incapable of discerning the line of demarcation between efficiency and efficacy you can be sure of catastrophic structural failures.
It is important to note that the "lowest cost per unit of output" isn't the sole consideration in decision-making. Factors like quality, market demand, environmental impacts, and ethical considerations can also influence production strategies. Additionally, in non-manufacturing contexts, such as service industries, cost-efficiency might take on different forms. The ongoing debate in boardrooms is how frequently decisions will be made with a balanced perspective versus being skewed towards lowest cost strategies in the pursuit of profit maximization. Consider, for instance, the numerous case studies of companies falling into this trap and suffering consequences in terms of reputation, ethics, and even bankruptcy.
The widespread and subtle issue of prioritizing the lowest cost per unit without considering the long-term effects has consequences on efficacy. Humans tend to be influenced by heuristic biases in decision-making, leading them to choose quick, uninformed decisions relying on the convenience of limited information. When humanity is collectively affected by these cognitive biases and consistently seeks the cheapest option, there is a risk of tipping the scales towards "efficiency" at the expense of efficacy.
Ultimately, this trend leads to a incremental descent into mediocrity across all facets of human life. In other words, people often focus on finding the cheapest option without thinking about the long-term consequences, which can hurt effectiveness. Our natural tendency to make decisions based on simple, quick judgments means we often choose what's convenient rather than what's best. When this mindset spreads across society, prioritizing cost over quality, it can lead to a gradual decline in standards in many areas of everyday life. Inconsequential if it is can openers. Extremely consequential if it is cardiac surgeries.
The most apparent and fundamental reason for pursuing the lowest cost per unit of output is to maximize profitability. Profit is the difference between revenue and costs, and when a firm lowers its production cost per unit, it increases the profit margin for each unit sold. This is critical in competitive markets, where prices are often set by external market forces, limiting the firm's ability to increase the sale price of its products. Therefore, the only viable strategy to enhance profitability, without increasing prices, is to reduce costs. By achieving the lowest possible cost per unit, companies ensure that they can reap higher profits without necessarily increasing the price paid by consumers.
For instance, in a scenario where two companies manufacture and sell identical products at identical prices, the company with a lower cost per unit will earn higher profits per sale. While this strategy may be beneficial for short-term profitability, consumers should be cautious about the constraints of cost-cutting measures. At the same time, consumers should also understand the law of diminishing returns in relation to the persistent drive for the lowest cost per unit of output. Eventually the process will cross the threshold of efficiency and begin down the treacherous path of declining efficacy.
Although this economic principle plays a vital role in competitive market strategies and remains a very valid tool, there are inherent risks in applying it universally. Consider the scenario where your preferred hospital aggressively focuses on cost-cutting measures for efficiency and profitability during the fiscal year when you must undergo cardiac surgery in that same hospital.
Remember, profit is the difference between revenue and costs. Ask yourself this very revealing question: which of these two levers (raise prices or lower costs) benefit the consumer in the for-profit companies in the healthcare industry. Another reason for the preference of the lowest cost per unit of output is the efficient use of resources. When a company or individual reduces the cost per unit, it often reflects better use of materials, labor, and capital.
Company strategies often justify efficient resource use which can be achieved through technological innovation, economies of scale, or better management of production processes. For instance, through automation or improved production techniques, firms can increase output without proportionately increasing costs, thereby lowering the cost per unit of output. An innocuous paragraph and an esoteric use of cost benefit analysis jargon. Let us decode it.
The previous paragraph contains coded language. All organizations face the challenge of ensuring the "efficient use of resources." Have you ever considered what the term "resources" truly encompasses? Since payroll is often the largest expense for a business, what do you think management is implying when they emphasize the need for "efficient use of resources"? Similarly, what do you think they mean when they promote "technological innovation through automation"? Efficient resource allocation is a cornerstone of productivity growth as firms and industries become more adept at producing more with less. Ever wondered, less of what?
The preference for the lowest cost per unit of output is rooted in its significant impact on profitability, competitiveness and resource efficiency. Whether driven by the desire to achieve economies of scale, or meet global competition, businesses across industries continually strive to lower their production costs in order to maximize profit margins. The paradox of pursuing the lowest cost per unit of output lies in the tension between minimizing expenses and maintaining long-term workforce satisfaction especially in the context of payroll costs being the biggest line item in the corporate spreadsheets.
This then creates a big dilemma for humanity in the 21st century. Given global industrial activities has reached a high point on the proverbial bell-curve and starting to push the limits of sustainability can our consumption patterns continue at the same pace without accelerating our ecosystem's destabilization in the near future?
Global investments in the rehabilitation and restoration of infrastructure and social services are bound to rise substantially over time as climate-related disasters become more frequent worldwide. Is humanity prepared to tackle these financial challenges within the framework of a cost-minimization economic model? How do humans reconcile the paradox of favoring lower taxes in the present while facing a future that requires increasing investments just to maintain, let alone improve, their standard of living?
Which then raises the big “elephant in the room” question: when scarcity becomes a global reality, and the epoch of abundance becomes a faint silhouette in our rearview mirrors, and inflation runs amok beyond the controls of the "wise" policymakers, and catastrophic system failures proliferate in "cascades" and empathy morphs into apathy, will altruism prevail among humans?
Think about it!