The cost structure business model defines the expenses that a company incurs as a result of its activities. Employees, infrastructure, expenditures connected with all operations, and sourcing through crucial relationships are among them.
The cost structure business model block displays all of the costs that your company incurs 90% of new businesses fail within the first three years because they do not grasp their expenses or the time required to provide the goods and services promised in their value propositions.
Cost Structure In Business Model
The term “cost structure” refers to all of the charges and expenses that your organization will experience while running your business model. This is the most critical phase in the process since it will enable your team to determine whether to pivot or continue.
The final but not least component of a Business Model is the Cost Structure. It collects the most significant costs associated with the entire process from the start. This is the final stage since we need to have all of the previous components established in order to estimate the expenses of each one.
This is due to the fact that constructing a Value Proposition, sustaining a Customer Relationship, and developing Revenue Streams all incur costs, just as the Key Resources, Activities, and Partners do.
On the other hand, some business models are far more cost-driven than others. So, let’s learn about the role and significance of the Cost Structure in your Business Model.
The term Cost Structure refers to the most significant costs spent when operating under a specific company strategy. Costs are incurred while creating and delivering value, preserving customer relationships, and producing money. After determining Key Resources, Key Activities, and Key Partnerships, such costs may be estimated pretty readily. However, some company strategies are more cost-driven than others. So-called “no-frills” airlines, for example, have created whole business models around low-Cost Structures.
Types of Cost Structure Business Model
Costs should, of course, be kept to a minimum in any company plan. Low-Cost Structures, on the other hand, are more crucial to some business models than others. As a result, it might be beneficial to separate two main types of business model Cost Structures: cost-driven and value-driven (many business models lie somewhere in between these two extremes):
Cost Driven Structures
Cost-driven structures are concerned with reducing costs or expenses. Companies that adopt a cost-driven structure reduce internal expenses through automation or outsourcing, resulting in competitive pricing. Operational excellence is frequently at the heart of the cost-driven business paradigm, as seen by Walmart and McDonald’s. Because margins are minimal, a cost-driven corporation must rely on economies of size and scope to obtain sufficient returns.
Economies of scale are the cost savings that a company obtains as it grows. A larger corporation, such as Walmart, benefits from volume discounts on the products it purchases, resulting in cheaper costs per unit.
Economies of scope are cost reductions that a company obtains as the breadth of its operations expands. For example, a prominent online retailer such as Amazon exploited its market dominance in online book delivery to diversify into other consumer goods.
Value-driven structures are concerned with increasing the value or income of premium items or services. Companies that embrace a value-driven structure develop premium goods by using consumer interaction and high-end components. Customers that purchase value-driven products and services are less price-conscious and place a higher emphasis on quality, performance, and convenience above price. Companies with value-driven frameworks include Nordstrom and Rolex.
Another aspect of a company’s cost structure that is known as Operating Leverage is the ratio of fixed to variable expenses.
High variable expenses in comparison to fixed costs have a lower upside return but also a lower negative risk. Low variable costs, in contrast to greater fixed costs, provide bigger upside benefits but much higher downside risks if break-even volumes are not reached.
When thinking about cost structures, evaluate what your most significant costs are that require more attention and have less of an influence on the quality of your product or service. You should also assess which critical resources and activities are the most expensive, as well as whether shifting up or down the value chain benefits you.
Characteristics Of Cost Structures Business Model
The way costs function is determined by their qualities. It’s critical to understand the distinction between fixed and variable expenses and, eventually, to be able to determine your break-even point.
Costs that are fixed
These expenses are often a defined percentage of your total expenses. While they do alter, it is frequently in little steps that they remain pretty consistent.
Here are several examples:
- Amortization. This is the progressive charge at the expense of an intangible asset’s cost (such as an acquired patent) throughout the asset’s useful life.
- Depreciation. This is the progressive charge at the expense of a physical asset’s cost (such as manufacturing equipment) during the asset’s useful life.
- Insurance. This is a recurring charge under an insurance policy.
- The cost of interest. This is the cost of a lender’s loan to a firm. This is only a fixed cost if the loan arrangement includes a set interest rate.
- Taxation on real estate. This is a tax levied by the local government on a firm based on the value of its assets.
- Rent. This is a recurring fee for the use of a landlord’s real estate.
- Salaries. This is a set amount of money provided to employees regardless of how many hours they work.
- Utilities. This is the cost of utilities such as power, gas, and telephones. This cost contains a variable component, but it is mostly fixed.
These expenses vary according to the volume of goods and services produced by a company. These include raw ingredients, transportation charges, and site hosting servers.
Here are a few instances of variable costs in a manufacturing setting:
- Materials that are direct. The raw ingredients that go into a product are the most simply variable expense of all.
- Payments for commissions/affiliate relationships A commission is an extra payment made by a firm to its employees. Employees may be paid commissions for surpassing their expectations and satisfying the needs of the organization. Most businesses pay sales commissions at a fixed amount outlined in a contract.
- Shipping Fees. Shipping costs are the expenditures spent when a corporation transports its products and raw materials from one location to another. This can be accomplished by waterways, roads, planes, or trains. Shipping expenses are variable in the sense that they fluctuate in relation to production and sales volume.
Economies Of Scale
Economies of scope are savings that occur when the cost of producing a group of items is less than the cost of producing them separately. Several items, for example, may share the same marketing efforts or Distribution Channels.
One of the benefits of large companies is that they benefit from lower costs with bigger volumes, which distribute fixed expenses more broadly, causing the cost per unit to fall considerably, lowering the average cost per unit. As a result, a larger firm’s cost per unit of production will be lower than that of a smaller company. A good example is when a large corporation purchases something at a significantly cheaper cost than a small firm.
Economies Of Scope
Economies of scope refer to the cost savings that occur when a company invests in numerous markets or expands its area of activities. If a corporation chooses to manufacture more items, the average cost of production lowers.
Economies of scope based on product diversification can be realized only if the multiple goods share common processes or the usage of a common resource. As a result, if both items demand identical marketing efforts or utilize the same distribution route, expenditure on marketing the products or distribution channels may be reduced per unit.
Scope economies provide several benefits to businesses:
- There is a lot of leeway in the product’s design and composition.
- The response rate has increased and response time has reduced in response to market-driven changes.
- Processes can be repeated with more control over their execution.
- Costs are lowered because waste is reduced in this company approach.
- Organizations can forecast changes and cycles more precisely.
- Software and hardware are used more effectively.
- A corporation that offers various goods, pursues multiple markets, or does both have less risk. Even if one product or market fails, the firm will have alternatives to enable it to survive while it rethinks its approach.
A typical blunder is underestimating day-to-day expenditures or strange items that come up that you hadn’t considered. These might be legal fees, such as submitting patents, or they could be anything else. The truth is that most business owners underestimate their everyday costs as well.
Allowing for an overall contingency proportion in your budgeting is the solution. Until you undertake comprehensive budget planning, a standard number of 10% will be sufficient.
How To Do Some Research On Cost Structure Business Model
Companies in a market with a dominating business model frequently have comparable sales and marketing partners, activities, and costs. You can get a decent feel of the costs they incur as well as the costs related to sales and marketing by looking at their publicly available reports.
Another advantage is that you may use this knowledge to think about how you might modify the business model, change the cost structure, and so create a more sustainable competitive advantage.
Doing your study can help you remove hazards and create a successful business model design.
Your cost structure is intimately tied to your value proposition as it pertains to the Business Model Canvas. A company’s cost structures indicate the exact expenses that the firm would pay while operating under a given business model to produce and deliver the business’s value proposition, as well as maintain its customer connections. To reduce costs, these expenses must be spread across all product or service offerings.
The cost structure business model of a corporation may be determined when it examines the important resources, key activities, and key partners that will be required. A vertically integrated corporation, such as one of the main six Japanese Keiretsus that can shift fixed expenses from one business unit to another, controls all of the essential resources, operations, and partner business units to choose which industry it wishes to dominate.
When it comes to analyzing the cost structure business model, the greatest choice for the small business owner is to look at the contact area between the firm and its customers, buyers, and suppliers.