How do you choose a cost structure?
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We often focus on business innovation. It’s important, but it’s also fun. Who doesn’t love revolutionizing an industry and changing the way people live their lives for the better? Innovation isn’t unchecked, however, no matter how much we wish it was. There are limitations, and frequently those limitations are due to cost. That makes Cost Structure an important component of your overall innovation strategy, and an important piece of all businesses. Cost Structure refers to all the ways a business approaches paying its bills. Such costs take many forms: the fixed cost of building rental, the variable cost of hourly wages, the sometimes unpredictable costs of repairs or disaster response. How a business prepares for fixed and variable costs, overhead expenses, production supplies, and any number of other concerns must be completely reflected in its cost structure. Financial accounting is a key activity in all business models, whether you employ an in-house accountant or simply a service provider to help you manage payroll taxes. In this article, we touch on some of the reasons why Cost Structure plays such a vital role in business innovation. We also discuss some ways to alter your Cost Structure to make innovation and transformation possible. The experts at Digital Leadership have plenty more to say about all of this, so don’t hesitate to reach out through our website. What is Cost Structure in the Business Model Canvas?Cost structure is a combination of the many expenses incurred over a set period of time, The Business Model Canvas introduces cost structure in various ways throughout the Business Model Canvas , and cost is always part of the equation when considering any innovation. Your overall approach to doing business must always consider cost structure, and you’ll need to identify which costs incurred by the business are unavoidable and among the key elements of your work, or represent investments that would be best used elsewhere. Always closely assign costs to innovation so you’re making the most of key resources. When considering cost structure, there are a number of specific elements to keep in mind. 1- Fixed CostsThese are costs incurred no matter how many goods or services the business produces. These costs tend to be recurring, like rent, insurance, or loan payments. A fixed cost is usually predictable. Fixed costs are often capital investments and other overhead costs. 2- Variable CostsA variable cost changes in relation to how many goods or services the business provides. While these costs can be predictable if the business is planning properly, they are not the same from one period to the next. Variable costs include direct labor costs, direct materials costs, and maintenance payments. 3- Cost AllocationThrough cost allocation, a business spreads the impact of a cost across multiple business units or cost centers. The result is that costs are much more tolerable on an instance-by-instance basis. When you allocate costs accurately, you more fairly reflect the impact, investments, and advantages certain business units experience as a result of such costs. Cost allocation usually takes one of four forms: direct labor, machine time used, square footage used, and units produced. 4- Cost PoolA cost pool is the total cost for completing one particular business activity, like manufacturing a product line or providing a service. The cost pool represents the total cost incurred across multiple segments of several business activities. For example, the costs associated with bringing a product to market would include manufacturing overhead, design, development, marketing expenses, piece rate wages, logistics, and any number of other fixed and variable costs connected to the product. Types of Cost StructureIn the Business Model Canvas, cost drives innovation as we seek to create value through unique cost strategies. While Cost Structure as a complete concept would take many articles to properly investigate, we have identified the primary components that should receive your attention early in your innovation and transformation efforts. 1- Value Driven Cost StructureProvide more value and generate more revenue through premium services and products. 2- Cost Driven Cost StructureCreate the leanest possible cost structure through automation, outsourcing, and using low-price value propositions. 3- Economies of ScaleCreate cost advantages as the output expands. 4- Economies of ScopeCreate cost advantages as the scope of operations expands. A Value Driven Business vs a Cost Driven BusinessIt’s easy to oversimplify our thinking when we compare a value-driven approach to a cost-driven approach, but we will keep things simple for now, and if you’d like to discuss these distinctions further, drop us a line. A cost-based pricing strategy and cost-based business focus on the company when determining price and services sold. A value-based pricing strategy and value-based business focus on the customer and how they perceive price in relation to value. For example, a cost-based company might supply a customer with a widget for the lowest possible price by sweeping away anything that contributes to raising the cost. These companies are often noteworthy for using maximum automation and extensive outsourcing. A value-based company sells a widget that addresses the same need, but perhaps provides personalized service or other elements of the purchasing experience that focus on the customer. In other terms, consider the differences between luxury hotels and bargain hotel chains. On the surface, both of these businesses provide customers with a place to sleep, but in reality, the customer experience is very different. Importance of Cost StructuresCost structures play a key role in the Cost Model of your Business Model Canvas. The cost structure concept helps guide how you target innovation and value proposition development. Through understanding cost structures, you can aim to reduce costs, as well as make the most from every cost your business incurs. Designed by: Digital Leadership AG – Building on the work of Alexander Osterwalder, the Lean Canvas, and the thinking of Patrick Stahler The UNITE Business Model Framework: A Framework for Innovation SuccessHow to Create Innovation includes a number of canvases that focus on value creation and finding the right business model to meet your customer segment and customer needs. The framework is built to inspire drastic changes that help you find a competitive advantage. Our hope is that your company grows through business model innovation, and so we again encourage you to look deeper into our website and the book. Here is a summary of the key ingredients of the Business Model Framework: Business ModelsThe centerpiece is the Business Model Canvas, which covers the six main areas of a Business Model (the Operating, Value, Service, Experience, Cost, and Revenue Models). The eXtended Business Model Canvas adds the immediate business context, including Business Drivers, customers, and the team, as well as the Unfair Advantage. Detailed ModelsA Business Model can be broken out into its numerous aspects. Depending on what challenges you face, you can zoom in on your area of interest using an appropriate tool or canvas:
How do you determine cost structure?The first step to make a cost structure requires breaking down all expenses into categories. They might include product-related costs, customer-related costs and employee-related costs, as a start. Then, within each group, calculate the associated fixed, variable, ongoing and one-off expenses.
What is a cost structure example?Examples include sales commissions, product cost, cost of labor and raw materials used in manufacturing, etc. Conversely, fixed costs are those that occur irrespective of the volume of selling or business activities. They are costs that accrue due to the passage of time such as insurance, salaries, and rent.
What are the types of cost structure?The four main cost structure types are: value-driven structure, cost-driven structure, economies of scale and economies of scope. The three ways you can analyze your business' costs are: cost allocation, cost behavior analysis and break-even analysis.
What are the basics of any cost structure analysis?Cost Structure is the relative proportion of each type of cost within an organization. Cost structure not only refers to the breakdown of costs required to manufacture a product (or provide a service) but also takes into consideration the use of all types of resources along the way.
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