What Is an Avoidable Cost?
An avoidable cost is an expense that will not be incurred if a particular activity is not performed. Avoidable costs refer to variable costs that can be removed from a business operation, unlike most fixed costs, which must be paid regardless of the activity level of a company.
Understanding Avoidable Cost
Avoidable costs are expenses that can be eliminated if a decision is made to alter the course of a project or business. For example, a manufacturer with many product lines can drop one of the lines, thereby taking away associated expenses such as labor and materials. Corporations looking for methods to reduce or eliminate expenses often analyze avoidable costs associated with underperforming or non-profitable product lines. Fixed costs such as overhead are generally not preventable because they must be incurred whether a company sells one unit or a thousand units. In reality, variable costs are not entirely avoidable in a short timeframe. This is because the company may still be under contract or agreement with workers for direct labor or a supplier of direct materials. When these agreements expire, the company will be free to drop the costs.
Example of an Avoidable Cost
In 2016, Procter & Gamble Co. (P&G) undertook a serious effort to rationalize its SKUs, eliminating dozens of unprofitable or low-margin brands from its consumer staples portfolio. Even though fixed costs—items like building rent, utilities, insurance, certain administrative salaries, etc.—still have to be paid despite a reduction in the SKU count, there are significant avoidable costs such as marketing and sales expenses and research and development expenses that P&G has removed from its operations. In any industry where price competition drives down profit margins, companies attempt to identify as many avoidable costs as possible.