What is Meant by Cost Structure?
A cost structure means the types and relative proportions of fixed and variable costs incurred by the business. The concept can be explained in smaller units, such as by-product, service, customer, product line, division, or geographic region.
The cost structure is employed as a means to fix prices if you are using a cost-based pricing strategy. It also depicts areas in which costs can be reduced or at least have better control. Therefore, the cost structure is a management accounting concept and has no applicability to financial accounting.
Break Up of the Cost structure
One needs to identify every cost incurred in relation to a cost object to define the cost structure.
The fixed costs are the costs of those items that remain the same irrespective of the volume of goods and services. On the other hand, the variable costs are such costs which vary in proportion to the volume of goods or services.
The key elements of the cost structures are as follows:
1. Product cost structure
- *Fixed costs: *Direct labour and manufacturing overheads
- *Variable costs: *Direct materials, production supplies, commissions, and piece-rate wages
2. Product line cost structure
- *Fixed costs: *Administrative overheads, manufacturing overheads, and direct labour
- *Variable costs: *Direct materials, production supplies, and commissions
3. Customer cost structure
- *Fixed costs: *Administrative overheads for customer service and warranty claims
- *Variable costs: *Costs of goods and services sold to the customer, sales returns, and credits received
4. Service cost structure
- *Fixed costs: *Administrative overheads
- *Variable costs: *Staff wages, bonus, tax deducted at source, travel, and entertainment
Certain costs aforementioned can be tough to define. So you may need to complete an activity-based costing outline to closely assign costs to the cost structure of the given cost object.
Use Cases of Cost Structure in Business Models
The cost structure explains all costs incurred to make a business model functional. Such costs can be computed easily after determining key resources, activities, and partnerships. The structure can be either cost-driven or value-driven.
Cost-driven business models minimise costs wherever possible, often through a low price value proposition, maximum automation, and extensive outsourcing. Whereas, value-driven companies focus on a premium value proposition often with a high degree of personalised service.
Designer clothes, luxury hotels, and asset management fall into this category. Economies of scale and the economies of scope are some of the important characteristics of the cost structure.
In order to develop the cost structure of your business model, a company should consider the most vital costs to the business and establish hypotheses for these expenses. Both the fixed costs, such as the startup and acquisition costs and variable costs, such as the monthly operating costs must be accounted for. After gathering the necessary data using available resources, the company will be able to check out if it needs to pivot or proceed for proving its hypotheses.
