What Is Aggregate Cost?
Businesses find it helpful to understand the aggregate cost involved with a given proposal or project when making decisions about the future. Aggregate cost refers to total cost involved with manufacturing a product, providing a service or carrying out a project.
Total cost figures must account for a wide range of variable and fixed costs that go into providing a service, making a product or completing a project. Variable costs encompass anything with a specific dollar amount the business can attach or costs that change depending on external forces and total production activity. These costs include material prices, shipping costs and utilities, among others. Fixed costs remain unchanged regardless of external forces and include loan payments, rent and salaries.
Businesses can also perform yearly aggregate cost analysis to better understand the costs of an ongoing project or change in operational procedure. If a business that historically provides a service moves into manufacturing a line of products related to its service, the yearly aggregate cost analysis helps the business determine whether or not to continue with the manufacturing venture. If the aggregate cost falls over time or remains steady, it probably warrants extending the experiment. If the aggregate cost rises without a corollary increase in profit, it probably signals that the experiment needs to be shut down.
Say, for example, that a business experiences enough growth that it approaches 90 percent production capacity and expects future demand increases. The head of operations suggests the business build another factory to meet the future demand. To aid the decision, the business owner asks for the aggregate cost of building the new facility and the aggregate cost of not building the new facility for one, two and three years. The business owner then gets to compare the cost of getting the facility built and staffed against the costs of pushing the existing infrastructure and staff to meet the projected demand. If the costs of putting the project off for a few years outweigh the costs of building a new facility, the business owner approves the initiative.
Deriving an aggregate cost for future activity often proves difficult. Any future projection must estimate variable costs based on existing information and historical trends, but it cannot account for external factors that alter future variable costs, such as abrupt changes in fuel or material costs. The projected aggregate cost must also estimate for human factors. For example, a business-wide change in software creates predictable costs, such as software licenses and training. It is much harder to predict the total loss in efficiency and the duration of efficiency loss as employees get up to speed on the new software, even though that efficiency loss contributes to the aggregate cost.