Every organization’s cost structure is closely tied to the type of activity it engages in, hence every business will have a different structure.
For instance, some companies will need more working capital than fixed capital, and vice-versa. Every organization strives to keep expenses as low as possible in order to maximize profits.
The size of the business affects these costs. Compared to businesses that operate on a large or worldwide scale, small businesses require less planning and research of these costs.
The purpose of this article is to clarify essential words, define cost structure, and give instances of how firms could use it.
What Is A Cost Structure?
A cost structure is the total cost of selling a good or service and the way those expenses are broken down. There are various ways to talk about cost structure, and not every company or expert would use the same terminology.
The major important thing is for you to comprehend how your firm operates with the cost structure and all the relevant tasks attached to it.
Cost structure changes most between several business kinds. Cost objects, such as products, services, customers, projects, and business activities, are some factors that might influence how a business refers to its cost structure.
Additionally, depending on product lines, business units, or divisions, cost structures may differ even within one company.
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Cost Structure Example
For illustration, let’s use the two companies X and Y as examples. Company X is a recently established business that has made significant investments in manufacturing equipment. In contrast, company Y, an established business that has been active in the manufacturing sector for the past three years, is preparing to outsource the production of its goods.
In comparison to company Y, company X has low variable costs. Company Y must pay a fixed agreed-upon amount for the purchase of produced goods, but this fixed cost is relatively low because the company has outsourced the production of the goods and is solely responsible for the purchase price.
Consider a scenario in which companies X and Y each have 5,000 units of their product and are selling it for $150 per unit. Company Y paid $210,000 for the product it outsourced, while company X paid $80 per unit. Now,
- Profit for Company X.
- ($150-80) x 5,000 units = ($70) x 5,000 units = $350,000
- profit for company Y.
- $(150*5,000) – 210,000 = $540,000
It is very obvious from the numbers above that Company Y has made more money than Company X since it has lower product expenses.
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Various Types Of Cost Structures
The two main categories of cost structure are as follows:
Cost-Driven
Low-cost goods and services are their areas of expertise for cost-driven businesses. These companies employ a range of processes and money-saving techniques to offer their customers the lowest prices feasible.
Cost-driven businesses must cut expenses in any manner possible, especially in areas that their competitors haven’t thought of because they still want to turn a profit, as most businesses do.
Discount airlines, shops that specialize in providing inexpensive products, and businesses that charge less for services than competitors are examples of cost-driven firms.
Value-Driven
Value-driven companies prioritize giving customers the best value for their money, even while their products or services might not be the cheapest.
Although they may be competitively priced, the most crucial factor for a value-driven company is that they truly think they are providing their customers with a fair value for their money.
An elite airline, a high-end retailer offering luxury items, or a service provider with extensive training are a few examples of this.
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Cost Structure In Business Model Canvas
A cost structure in the business model canvas incurred is a result of its operations described by the canvas cost structure. Personnel, infrastructure, and all-around activity costs that are sourced through the key partnership are among them.
The cost structure building block lists every expense your company has incurred. Because they don’t grasp their costs or what it will take to produce the products and services they promised in their value propositions, 90% of new firms fail within the first three years.
The post-mortem reports of 101 startups were examined by CB Insights for a different study to come up with a list of the Top 20 Reasons Startups Fail. The second spot is “run out of money.”
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Features Of Cost Structure
The characteristics of a cost will determine how it works. Meanwhile, it’s fundamental to know and understand the disparity between fixed costs, and variable costs and eventually to be able to evaluate your break-even point.
Fixed Cost
These expenses often represent a predetermined percentage of your total expenses. While they do alter, the changes are frequently small and they stay largely constant.
Variable Cost
Depending on how many items and services a company produces, these costs vary. These include items like shipping fees, server costs, and raw materials.
Economies Of Scale
This is known as savings that result when manufacturing a variety of goods together is less expensive than producing them separately. As an illustration, many products might utilize the same marketing strategies or Distribution Channels.
Large organizations have the advantage of lower costs due to higher volumes that more evenly distribute fixed costs, resulting in a sharp decline in cost per unit. As a result, the average cost per unit has decreased.
Therefore, a larger company will produce at a lower cost per unit than a smaller one. An example is when a large firm purchases something and pays significantly less than a small company.
Contingency Cost
Underestimating daily costs or strange occurrences that occur that you haven’t anticipated will be a common mistake. These fees could be for filing a patent, for example, or they could be for anything. In actuality, most business owners underestimate their everyday expenses as well.
The clue is to include a proportion for general contingencies in your budgeting. For now, a usual percentage of 10% will do until you complete the thorough budget planning.
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What Is Cost Structure Breakdown?
A breakdown or hierarchical representation of the various project costs is known as a cost breakdown structure or CBS.
The Work Breakdown Structure’s component costs are represented by the Cost Breakdown Structure (WBS). The CBS gives a framework for implementing quantifiable cost controls and is an essential tool for controlling the financial aspects of any project.
For Project Business to effectively handle the financial element of any project, the CBS is necessary. It is the framework for planning that financial controllers use to develop budgets and compute numerous financial measures. This includes earned value and estimate at completion, the cost to finish, and variations.
Conclusion
Cost structure primarily refers to the expenses that must be incurred to carry out the objectives of the organization; this cost structure may include purchase costs or manufacturing costs, which include the price of raw materials, labor costs, and other overhead expenses like transportation costs, electricity costs, etc.
The cost structure concept is intended to put out the financial resources we require for a certain company sector or the entire organization.
Cost Structure FAQs
Why Is It Important To Know Your Cost Structure?
Finding out the cost structure and how it should be allocated can also help determine which items are the most and least profitable. A company can then effectively allocate its resources to the creation and marketing of more lucrative goods.
How Do You Analyze Cost Structure?
The relative proportion of each form of cost inside an organization is known as the cost structure. Cost structure includes not only the breakdown of expenditures involved in producing a good (or providing a service) but also the utilization of various resources used along the way.
How Can Cost Structure Help Your Business?
The cost structure, a crucial component of any business model, has a direct impact on several aspects of your company, including your profit margin and product lineup, among other things. While the specifics differ from firm to business
