Average cost is the cost per unit manufactured in a production run. To calculate average cost, aggregate all fixed and variable costs associated with a production run, and divide by the number of units produced.
For example, ABC International's manufacturing department completes a production run of 10,000 widgets. The fixed costs of the production run were $30,000, plus $2 of variable costs for each unit produced. The resulting calculation is:
($30,000 Fixed costs + $20,000 Variable costs) / 10,000 Units = $5 average cost
The average cost concept is most applicable to lengthy production runs, as may be found for highly standardized products that are produced and sold in large quantities. In these situations, a significant competitive advantage may exist when a business can reduce its average cost per unit, since this allows it to lower prices and gain market share from competitors.
The average cost concept has little application in a custom production shop or one that produces to order in small batches; in these situations, the competitive advantage is more likely to be associated with attentive service or fast turnaround time.