Cost Structure: understanding what it really costs
The Cost Structure describes all costs incurred to operate a business model. Understanding your cost structure helps you make smarter decisions about where to invest, what to cut and how to price.
Cost Structure: understanding what it really costs
The Cost Structure describes all costs incurred to operate a business model. Every business model creates costs. The question is whether they are understood, justified and managed. In our experience, they usually are not.
Two types of business models by cost focus
Cost-driven The focus is on minimising cost wherever possible. Budget airlines and discount retailers. The value proposition is partly built on low price.
Value-driven The focus is on creating maximum value, even at higher cost. Premium hotels, bespoke consulting firms and luxury brands.
Most businesses sit somewhere between these extremes. The problem is when they have not decided where they sit. Trying to be both usually means being neither.
Fixed vs. variable costs
Fixed costs remain constant regardless of output: salaries, rent, software licences and insurance.
Variable costs scale with output: materials, transaction fees, delivery costs and cloud computing costs beyond a baseline.
Understanding this split matters when you are thinking about pricing. A business with mostly fixed costs has very different margin dynamics than one that is mostly variable.
Economies of scale and scope
Economies of scale: costs fall on a per-unit basis as production volume increases.
Economies of scope: costs fall when producing multiple products together is cheaper than producing them separately.
Common cost structure mistakes
- Underestimating fixed costs: many businesses underestimate the true fixed cost base, particularly personnel costs.
- Confusing investment with cost: some costs like R&D, brand building and infrastructure generate future value and should be treated differently.
- Not reviewing regularly: cost structures drift over time. Something that made sense two years ago may no longer.
Questions to explore with clients
- What are your biggest cost categories, and are they directly linked to value creation?
- What proportion of your costs are fixed vs. variable?
- Which activities are you doing in-house that cost more than the value they create?
- If you needed to reduce costs by 20%, where would you start, and what would the trade-offs be?
- Are there costs that are growing faster than your revenue?
- What costs could you reduce by partnering with someone else or adopting a different technology?