The business plan model is a framework that systematically analyses delivering value to customers and hence optimizes the long-term value of the business. It helps to design, test, and understand assumptions about the market and make changes to the business model accordingly. The cost structure is a critical part of the business model as it is used for understanding various costs within the business. Besides, it is important to identify the changes in cost structure as the business grows, and make changes accordingly. In this article, we will investigate how to minimize costs and maximize value.
Cost Structure Business Model
In the business model, cost structure explains the different costs that are involved in business operations. For example, it includes infrastructure, employees, sourcing, logistics, etc. The different types of cost structures are cost-driven and value-driven, and they are characterized by fixed costs, variable costs, economies of scale, and economies of scope.
According to a survey, 90% of start-ups fail because they fail to have a clear understanding of the costs they incur as a business. They do not know what it takes, or the costs involved to create goods and services promised in their value proposition, and due to this, they run out of money. So, when reviewing the cost structure, you must identify where the key costs will be, and they are listed below.
- Important activities
- Important partnerships
- Customer relationship
Key Questions To Ask When Analysing Cost Structure Business Model
Listed below are the important questions that you must ask when analyzing the cost structure in a business model.
- What are the costs that are inherent or fundamental to the business?
- What are the most expensive key resources of the business?
- What are the most expensive key activities of the business?
- How are the key activities driving up the cost of the business?
- Are these key activities matching with the value propositions of your business?
- Are the costs of your business becoming variable or fixed when you shuffle the business model?
- Is your business cost-driven or value-driven?
Getting a clear answer to these questions helps you to optimize the cost structure and thereby the business model remains close to or within the value propositions. As a result, the long-term value of your business is optimized, and this is especially important to avoid the failure of start-ups. In the next section, different types of cost structures are explained in detail.
Different Types Of Cost Structures
In a cost-driven approach, the focus is to reduce costs as much as possible, and this can be achieved by automation, outsourcing business processes, optimizing logistics, etc. So, its primary task is to maintain a lean cost structure through various approaches, and the best example would be budget or low-cost airlines that are common nowadays.
In a value-driven approach, the business focuses on providing products with maximum worth. Here, cost implications have a lower priority because the approach is to give tailormade and personalized products and services to maximize the gains for the customers. The best example for this type of business would be luxury hotels, automobiles, premium electronic devices, etc.
The Different Attributes Of Cost Structures
The working of cost structure depends on its attributes, and they are discussed in detail below.
Fixed costs are those that remain at a fixed percentage of the overall costs even after the volume of goods and services produced is increased. But their increase is incremental and remains stable, and some of its examples are listed below.
- Interest expense
- Property taxes
These costs vary according to the volume of goods and services produced by the business, and listed below are some examples of it.
- Direct materials
- Affiliate payments or commission
- Shipping costs
Economies Of Scale
Economies of scale are the savings created by the overall cost when it is cheaper to produce a range of products together than producing them individually. You can see this when big corporations or companies expand. This is because, as the volume of production increases, the fixed costs are spread more thinly, and it reduces the production cost per unit volume. Hence, the production cost per unit output is significantly lower for a big company compared to a smaller one.
Economies Of Scope
Economies of scope are the cost advantages a business enjoys when it chooses to expand its operations into multiple markets. Due to this, the average production cost decreases as more goods and services are produced. A business can also achieve this by product diversification if the different products share common resources or processes. For example, this can be seen if different products require the same distribution channels or similar marketing efforts. The advantages of economies of scope are listed below.
- It decreases the response time and increases the response rate to market-driven changes.
- Due to the minimum wastage of resources, costs are reduced.
- It offers more flexibility to the design and mix of the product.
These are some of the important points that you must know about cost structure in the business model, and we hope that the details shared above were of help to you.