Many entrepreneurial companies face challenges in calculating their true cost of doing business. The ability to overcome these challenges can create a significant competitive advantage.

We live in an age of nickels and dimes. Customers split hairs over price, and make purchasing decisions based on marginal differences in the way their providers deliver products and services. Knowing true costs opens the door to making better decisions that impact the value proposition, pricing and other strategic considerations.

Most commonly, the problems with calculating costs stem from poorly integrated systems and a lack of cost accounting. Gross margins are typically understood by senior management, but overheads are allocated with a lack of specificity. They are applied evenly based on the volume of a category or division, even though there may be significant differences in corporate overheads from one to the next. If the systems do not allow for true cost accounting, even true margins- which reflect things like discounts- may not be accurate.

Problems can be exacerbated by an inherent lack of financial acumen. Non-financial managers need to be taught how profit is earned and how it is calculated. That may not mean cracking open the books, but education at a gross margin level is critical for companies wishing to empower mid-management to make better decisions on their behalf.

There are several strategic planning tools that are useful to better understand costs and their relationships to value:

Activity-Based Costing – A well-executed Activity-Based Costing (ABC) analysis can yield meaningful results. In an ABC (often conducted by a CPA or consultant), the organization measures which of its activities are tied to specific products, segments or divisions. This is painstaking work. For example, all corporate staff may be required to track their time for a fixed period (maybe 2-4 weeks) so that such allocations can be calculated. Once these costs are understood, a provider can make better decisions about where to reduce costs, what products and services to offer, and what prices they should charge (which in some cases is very different than what the market will bear).

Value Chain Analysis – Value Chain Analysis breaks down the activities of a firm in its basic elements such as R&D, product development, product launch, etc. Then the value of these activities (as perceived by customers) is weighted against the ability of the firm and its competitors to deliver value. For example, customers may value warranties as a differentiator among companies. Some competitors (such as BMW or Hyundai) may excel in this area, which could be a source of some advantage. What is critical, however, is that providers measure the perceived value of the feature versus the incremental cost to provide it.

In a world where customers’ cost sensitivities are heightened, having a laser focus on costs allows providers to manipulate their offering and prices to create the optimum perceived value.