Question

Can cost distortion also be prevalent in service related industries? Why or why not?

Answer 1

Generally In a free commodity based market, the prices of individual commodities are set by the laws of supply and demand. An increase in demand or decrease in supply usually results in a higher price, while a decrease in consumer demand or an increase in supply usually results in a lower price. When the price of a commodity does not seem to follow the laws of supply and demand, it is sometimes referred to as a cost distortion, price distortion or market distortion.

In a service related industry, the proportion of cost of goods required for providing that service ( consumables ) is generally negligible in proportion with other cost such as labor when compared with production related industry. Variable cost per unit can vary from time to time and customer to customer based on a particular instance. Due to this uncertainty in cost, when fixing price for services, the effective cost of material and labor may be inaccurate. Prices are also generally higher since priority is on providing quality of service. Quality of service is a metric which cannot be easily measured or established in a value per dollar basis. Established service related companies tend to have a higher perceived quality of service and tend to command a premium over competitors. they may also benefit from economies of scale further cutting down and distorting their overhead costs estimates on the books and records.

On the contrary, a smaller business may underestimate its costs due to not accounting for unexpected increases in the overheads and the need to provide a competitive price. this intangible attribute of services related industry can lead to cost distortion in most cases.