Cloudonomics: The Business Value of Cloud Computing, + Website

Delivered Cost

Unit cost and economies of scale are concepts that date back to the early days of manufacturing. They are generally useful but somewhat misleading when applied to service businesses, for reasons that are worth considering for a moment.

In production operations, the concept of unit cost is based on the notion of a factory that is producing at capacity and is completely decoupled from customer demand. Generally, as production facilities expand in size, various costs may proportionally increase (diseconomies), remain the same, or decrease, that is, exhibit economies of scale.

An important issue, however, is that the nature of demand does not enter the picture: Unit cost is based on total cost divided by production volume at capacity. If not sold, goods that are produced are carried as inventory, leading to inventory holding costs, which can include floor space, automatic storage and retrieval systems, labor costs to move inventory around, costs of obsolescence, and insurance or risk-adjusted costs of damage or destruction. In a manufacturing business, the price paid by the customer for a unit of production is a function of the unit cost of production, plus inventory carrying costs, plus additional components of the cost structure such as sales, general, and administrative, margin, financing operations, and so forth.

In manufacturing, output can be constant, and demand variation can be buffered with inventory throughout the process: raw materials inventory, work-in-process ...