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Are you looking to cut costs and maximize value in your business? If so, you’re not alone. The cost structure is a critical factor for businesses of all sizes. This article will discuss cost structure and outline some tips to help you reduce costs and get the most out of your spending. Let’s get started!
What is Cost Structure?
The cost structure refers to a list of all the costs that a business incurs. It typically includes fixed costs and variable costs. Cost structures are the different proportions of fixed or variable costs incurred by a business. Fixed costs do not change regardless of how much output a company produces. On the other hand, variable costs can be altered with increasing production volumes.
Whether the business is a service provider or a retailer, it must incur costs. However, the cost structures of service providers and retailers differ. Hence, the expense accounts on financial statements will vary depending on the cost objects (e.g., a product, project, customer, or business activity). In addition, due to the different activities performed, cost structures can vary within a company.
Related: Cost Leadership Strategy
Cost Structure Attributes
Every category on an organization’s cost structure will have attributes specific to the type of expense involved. Let’s look at some common categories.
– Economies of Scale
As the business increases its output, variable costs will decline due to a reduced unit cost of production. This is known as economies of scale, and these savings can be attributed to the company’s size.
– Economies of Scope
If a business organization engages in multiple or integrated activities, it can achieve particular efficiencies that larger organizations enjoy. For example, an engineering company may hire engineers and support staff to integrate their services and share resources better. This is known as economies of scope.
– Fixed Costs
These costs remain unchanged regardless of how much business activity is done. An example of a fixed cost would be rent, which remains the same every month even if you choose to work half-days for a week. You pay the total monthly amount no matter what.
– Variable Cost
In contrast with fixed costs, variable costs change depending on the level of business activity. For example, if you’re a local farm shop and you decide to work an extra day at your stand due to high customer demand, your variable cost would be the additional products you make available for sale.
How to reduce Fixed and Variable costs?
Reducing fixed and variable costs is essential to any business. There are a few ways to reduce monthly operating costs or fixed costs. Here are some tips to get started.
First, automate processes to reduce direct labor costs: Hiring staff for specialized tasks suitable for automation. For example, tax preparation can be automated by using software or hiring specialists who have advanced knowledge of tax regulations.
Utilize third-party resources: If you have the time and money, consider outsourcing some of your service delivery so you don’t have to pay for internal labor costs.
Minimize the number of employees: The most straightforward way to cut costs is to minimize the number of employees you have on staff. You cut back on the payroll, benefits, and other costs by either firing employees or not hiring new ones.
Negotiate with suppliers: Suppliers are always looking for ways to improve your company. Make sure to regularly stay in touch with the vendors that provide services and products to your business. Discuss their product offerings, sales quotes, and any other services they may provide. Then, negotiate with them to see if you can get a better deal, price, and terms.
Bundle services: If you have more than one service provider, see if they offer discounts for bundling services. For example, many providers offer discounts for having cable, internet, and phone service from them.
These costs typically change depending on business levels. However, there are several ways to reduce variable costs:
Outsource non-core tasks: A great way to save on variable costs is to outsource non-core tasks where you don’t have any particular expertise or skills. You can find many companies that provide these services at a low cost.
Use less expensive suppliers: If possible, use less costly suppliers for everything from office materials to raw materials for production. Not all suppliers are the same, and the cheapest is not always the best option.
Increase production: It is often more cost-effective to increase production output if you find excess capacity or resources. This will minimize the number of resources and cash-flow tied up in those resources not being used (opportunity costs).
Set clear goals with a budget and a timeline: While it may be difficult, set clear goals for your business on what you are trying to accomplish. From there, determine the budget you will need and establish a timeline to see if you can afford it.
Managing fixed and variable expenses is essential for any business because they represent the direct costs to an organization. Managers must manage them both while ensuring that it remains profitable. Companies can successfully reduce fixed and variable costs by having clear goals and communicating them to employees by leveraging automation technologies.
Related: 6 most commonly neglected cost savings
Cost allocation refers to the process of identifying the costs incurred and then adding them up and allocating them to the appropriate cost objects (e.g., product lines, services lines, departments, business units, or customers) on a measurable basis. Cost allocation can be used to allocate costs between different cost objects to determine the profitability of other product lines.
The key to cost allocation is to ensure that all costs are accounted for and that each part of the project or organization pays its fair share. This ensures that everyone involved in the project or organization knows the costs and can make decisions accordingly. It also helps to ensure that adding new parts to the project or organization does not increase the costs of existing parts.
A cost pool is a grouping of costs related to a specific activity or project. Such costs in the pool are then allocated to individual products or services to assign the costs to the particular items. The cost pool is used as a method of indirect assignment of costs. The main benefit of using a cost pool is that it can be allocated consistently.
Importance of Cost Structures and Cost Allocation
The cost structure of an organization determines the amount that each type of product or service costs. The more products and services produced, the more likely it that fixed costs will become too expensive, leading to increased variable costs. These increased variable costs can lead to higher prices for consumers.
If organizations do not allocate their fixed and variable costs correctly, it can lead to poor decision-making. The allocation of costs should be based on the activities required for each type of product or service and not be biased by what will reduce the overall costs for the organization as a whole. An example would be if an organization has one server to support all their services, but only one of those services requires that server. The costs of running that server should be allocated to only the service using it and not all of them.
For example, if a company has five departments with different costs associated with them. Still, regardless of what they are producing, the company only allocates 20% of its capacity to each department. If the five departments make 20% each, then this is fine. However, suppose one department only produces 10% because other departments use 80% of their overall capacity. In that case, it will show as unprofitable when it is profitable for that department.
Business Model Canvas
A Business Model Canvas (BMC) is a simple, nine-block diagram that helps you sketch out your business model. It’s a great way to start thinking about how your business works and identify areas for further refinement.
In their book, Business Model Generation, Alexander Osterwalder, and Yves Pigneur explain how the BMC can be a stepping stone to more robust business models. It’s a great visual tool for business strategists, consultants, and entrepreneurs alike.
There are nine blocks on the business model canvas: customer segments, value proposition, channels, customer relationships, resources, activities, cost structure, and revenue streams. Each block is filled in with information about who your customers are, what you offer them, and how you’re going to deliver that value.
The canvas consists of nine elements:
- Customer segments: Describe your customer or clients in terms of their demographics, location, needs, and wants.
- Value proposition: What value will you provide to each segment?
- Channels: How will you deliver the value proposition to your customers?
- Customer relationship: For example, how will you manage their experience with your business?
- Resources: What resources will you require to deliver the value proposition and support the customer relationship?
- Key activities: What activities will you use to create and deliver the value proposition?
- Key partners: Who do you depend on for resources?
- Cost structure: What will your company’s cost structure look like?
- Revenue streams: How will you generate revenue? Which activities contribute directly to revenues and which only support the key activities?
A business model canvas is the first step in developing your initial business or idea for an existing company. Once you’ve drafted the Business Model Canvas, use it to review your assumptions, evaluate the opportunity, prioritize features, manage risk—and most importantly, create actionable next steps!
The Business Model Canvas is a simple visual representation of a company’s business model. It is a way for businesses to organize their thoughts and develop new ideas.
Organizations can use this technique to show how their products or services create value for customers and the business by creating direct revenues and reducing fixed costs to make them more profitable.
So, what can you do to reduce costs and get the most value from your spending? Here are a few tips:
- Evaluate your cost structure and make changes where necessary.
- Streamline operations and optimize processes.
- Use technology to automate tasks and improve efficiency
- Negotiate lower prices with suppliers
- Cut out unnecessary expenses
- Invest in training and development for employees
- Share information and collaborate with other businesses
- Subscribe to our blog for more helpful tips!
Do any of these steps resonate with you? What will you do to reduce costs in your business? Let us know in the comments below or on Twitter @interobservers.
We hope this guide has given you a few new ideas about how your organization can save money without sacrificing quality or effectiveness in its service delivery. Please share this guide with anyone you think would benefit.