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What Is Absolute Cost Advantage?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 20 August 2016
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Absolute cost advantage is a type of competitive situation in which a business is able to achieve and maintain a level of operational cost that makes it very easy to compete in the marketplace and turn a profit on every unit sold. This type of competitive advantage often involves the ability to effectively manage such expenses as the cost of raw materials, the selection and maintenance of equipment used in the manufacturing process, and basically any other type of overhead involved in the business operation. When an absolute cost advantage exists, the company is able to consistently maintain that low cost of operation, making it possible to not only compete in the marketplace based on quality but also on price.

While many companies are able to achieve some sort of cost advantage on a short-term basis, achieving an absolute cost advantage means not only achieving but maintaining that advantage over a period of time. This is often managed by locking in the best possible pricing for items that are considered fixed costs as well as variable costs. For example, a company may be able to use a volume purchasing agreement to acquire and maintain a considerably lower unit cost off raw materials for a period of several years, even if the standard cost of those materials should increase significantly during that time frame.

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The benefits of absolute cost advantage to any business operation are considerable. One of the immediate advantages is lower operational costs which in turn make it possible to generate additional profit off each unit produced and sold. Even if market conditions require that production is lowered to meet a temporarily lower demand, or if a reduction in retail pricing is necessary in order to compete with other providers for a period of time, there is still a good chance of making at least some profit off each unit sold. This in turn means the company has a better chance of surviving an economic downturn than any competitors who have not achieved this advantage and are more prone to fluctuations in their operating costs.

Actually achieving an absolute cost advantage requires a great deal of work and attention to detail. Companies typically must work toward this goal incrementally, paying attention to each aspect of the operation that can be fine-tuned to offer the best possible return for the least amount of cost. Along with the cost of materials and the use of equipment in the operation, identifying the best possible ways to manage the cost of labor as well as putting together an effective management team is crucial during this phase. Once the absolute cost advantage is achieved, constantly monitoring each aspect of the operation and managing those costs is necessary in order to keep that advantage from slipping away from one period to the next.

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serenesurface
Post 3

I guess absolute cost advantage is the reason why some newly developed nations are taking over the global economy. They have cheap raw materials and they pay their workers less. Naturally, countries like China and Mexico have absolute cost advantage over many goods now.

turquoise
Post 2

@literally45-- Well, that's the nature of the marketplace. Only the strong firms can survive. If a business cannot maintain absolute cost advantage in a good, it has to switch to another good that it has absolute advantage in. If it doesn't, it may go bankrupt as you said.

The only exception is in industries where there are government subsidies. The government can subsidize certain businesses to keep them afloat even when they don't have absolute cost advantage. It's actually common in the US, for example, in the agriculture industry.

literally45
Post 1

Absolute cost advantage doesn't just benefit businesses. It also benefits the consumer. If a business can produce something at a low price, it will be more affordable for me to buy, even after the manufacturer adds in profit.

I guess the only downside of a business that functions at an absolute cost advantage is that it's bad for competitors. Businesses that can't compete with these prices will be pushed out of the industry.

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