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The cost structure piece of the business model canvas helps you create a list of all the costs you will incur to operate your business.
Now, when I say “all costs for your business”, I should clarify that these are the more important and bigger costs. But as you go through this example, if you come up with additional costs I would absolutely keep them on the list. It might be helpful to add a star next to those that are the bigger costs so you can differentiate.
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What is a Cost Structure
Cost structures are the different proportions of fixed or variable costs incurred by a business. There’s even small-scale examples such as which type of product or service it is, who you’re getting that from, what geographic region this person lives in; these all factor into your company’s cost structure.
A businesses cost structure is a component of the business model canvas, which is a helpful tool that can help you figure out ways to strengthen and grow a business.
As a reminder, here are the other pieces of the business model canvas you might want to use to jog your memory:
- The key activities for your business
- Strategic partnerships you’re going to be seeking out to grow your business
- The channels you’re going to use to reach your customers
- Revenue streams you’ll be taking advantage of
- Building customer relationships and how this will impact your cost
- The unique value proposition for your business
- The customer segments you’ve determined you will be providing value to
By taking a look at these, you should be able to figure out some costs you will be incurring as well as the type of cost structure you’ll be operating under. But there are probably some more we’ve missed. Let’s turn to the types of cost structures as well to find more.
Types of Cost Structures
Cost-Driven
These types of businesses are hyper-focused on minimizing costs wherever they can. They want to create the lowest price cost structure by taking advantage of systems, automation and outsourcing.
When making a buying decision, they rank cost above all other parts of a transaction.
Some examples of these businesses are:
- Spirit Airlines – you buy the ticket for a flight, and then essentially everything else comes at a cost. Whereas other airlines includes things like in-air snacks and drinks, or seat selections.
- Walmart – another brand who is touting “always low prices” and brings in many cost-conscious customers.
Cost-driven brands tend to have less loyal customers than those who are driven by value, but that’s not to say these companies aren’t pulling in the big bucks. And I’d argue that there are a TON of people who are loyal to Walmart because they are saving money.
Value-Driven
Value-Driven cost structures are staples to companies that are more concerned about creating value than how much it costs them to do so.
Of course, every business needs to make money, so they aren’t just spending money on the most expensive options all the time. It just means that if it came between 2 options:
- One that aligned with their values and cost $10 per unit OR
- One that was $8 per unit but wasn’t necessarily congruent with their values
They would go with the $10 unit because they aren’t solely focused on being low cost.
Attributes of Cost Structures
It makes sense to talk about the characteristics of costs that come along with either business model because it helps us to determine those main drivers of the cost we’re looking to figure out.
Fixed Costs
Fixed costs are expenses/costs that stay the same no matter how many goods or services are sold. For example, rent or a mortgage is the same if you have 1 client or 10 clients, granted you don’t need to expand your space to accommodate those clients.
Here are some other examples of fixed expenses:
- Rent
- Property taxes
- Salaries
- Utilities
These are expenses that you must pay regardless of whether you have a bad month and have no clients, or if you have 100 clients they are generally the same.
Of course, some of these might vary slightly month to month, but overall they are the same.
Variable Costs
Compare those fixed expenses to variable costs, which change based on the amount of work you do.
Variable costs increase or decrease depending on a company’s production volume; they rise as production increases and fall as production decreases.
Examples of variable expenses:
- Materials – i.e. ingredients of a product you have to produce
- Payroll taxes
- Commissions & Bonuses
- A tool you used that charges based on client (reporting, research, etc.)
Economies of Scale
These are benefits a company or business enjoys as their business grows. These benefits are such that they cause “cost per unit” or “cost per customer” to decrease as they produce more work.
Examples of Economies of Scale:
- Bulk discounts on products
- Discounts on software
Here is an example of pricing that reflects economies of scale with a company called Jira. For smaller teams, the pricing ends up being around $10 per user. But if you have 11 or more people on your team it’s only $7 per user.
While this might be a basic example of this type of scale benefit, it’s still valid.
As a company puts out more work, their vendors generally start giving discounts because they are providing them with more sales.
Economies of Scope
These are cost advantages that businesses get as they expand their operations scope.
Just because a company adds on a new product or service doesn’t mean they’ll get this benefit. It only works if the two services are well-aligned and share processes or use similar resources.
For example, for my marketing team we help clients run Facebook ads so we have marketing software, reporting tools, knowledge on how to run paid traffic, etc.
If I were to add in Google Ads as a service (which I already do, but it’s for the example!) then we would definitely benefit from economies of scale:
- The reporting tool can handle both platforms
- Paid traffic knowledge ( can be beneficial in both situations
- Some of the software is similar and can be used with both
Now, if I ran Facebook ads and wanted to help clients with finding caterers for their events, there isn’t much overlap there and I would not be benefiting from economies of scale.
Cost Structure Example Exercise
Now, you can get as granular or broad as you’d like here, but it’s important to do enough to get a good understanding of what your cost structure will allow, and prohibit you from doing.
Here’s a basic example of how you can complete this as an example:
Type of Cost Structure: Value-driven
While cost is important to keep in mind, if we aren’t providing enough value we wouldn’t have any clients. The goal of the business is to help other businesses grow, and to do that we need to put our best foot forward, not our mediocre foot with a cheaper shoe on it.
Fixed Monthly Costs:
- Cell phone: $90
- Quickbooks: $10
- Computer: $50
- Management salaries: $3,000
Variable Monthly Costs:
- Invoicing Tools: $49
- Marketing: $100
- Employees: $3,000
Economies of Scale:
- By increasing the number of clients, we can benefit from software and marketing economies of scale. As well as utilization of space and tools.
Economies of Scope:
- Adding new services that help clients while utilizing similar processes and tools.
Thank you for this article.
What would be the determinants of the cost structure