Square Root Costing: What Does Complexity Really Cost?
Square Root Costing: What Does Complexity Really Cost?
Square Root Costing: What Does Complexity Really Cost?
todays corporations. Too often, companies assume economies of scale as more volume is pushed through their operations, but volume often generates complexity, the opposite of scale. Square Root Costing allows a company to determine where the business has truly achieved scalability and where complexity costs are eroding profitability. Square Root Costing also has the advantage of being more dynamic than more time-consuming costing models such as Activity-Based Costing. Since Square Root Costing can predict cost changes based on variables such as volume, it aids not only in understanding true costs, but also how those costs change pending shifts in volume, or the supposition of scale. It answers the question: at what volume would Product A achieve profitability, if at all? And it does so, incorporating the impact of complexity.
how costs change pending shifts in volume, takes a matter of weeks versus activitybased models which may take six months to a year. This allowed the company to quickly apply the thinking to other products in its portfolio. Standard Cost View
$/unit 140 120 100 80 60 40 20 0 A B C D E F
Volume: 1500 1000 600 200 100 50 Profit:
Sales price NVA cost VA cost
8% 11% 7% 7% 6% 6%
Complexity-Adjusted View
$/unit 140 120 100 80 60 40 20 0 A B C D E F
Volume: 1500 1000 600 200 100 50 Profit: NVA costs typically shift toward lower vol. products
Figure 1. Square Root Costing Provides More Accurate Views of Costs and Profitability
Wilson Perumal & Company, Inc. Two Galleria Tower 13455 Noel Road, Suite 1000 Dallas, TX 75240
www.wilsonperumal.com