Cost Structure

The Cost Structure in a Business Model Canvas outlines the key costs a business incurs. It identifies the most significant expenses related to delivering value, maintaining customer relationships, and generating revenue.

These costs could include fixed costs (like rent and salaries), variable costs (like raw materials), and operational costs (like marketing and production). The goal is to understand the significant financial drivers and optimize cost efficiency.

 It gathers the most essential costs involved in the operation from the outset. This is the final block precisely because we need to have all the previous components defined so we can estimate their costs.

Creating a Value Proposition, maintaining Customer Relationships, and developing Revenue Streams all generate costs, as do Key Resources, Activities, and Partnerships. Each of these components requires financial investment to operate effectively.

However, some business models are more cost-driven than others. Let’s look at some examples of Cost Structure in a business model.

Cost Structure Examples

Below are examples of Cost Structures in various industries to highlight how different business models manage their indirect and direct costs:

1. E-commerce Business: E-commerce companies operate in the digital space, providing them with opportunities to minimize certain physical costs but still face significant expenses. Here are the key cost components:

• Technology Infrastructure: Developing and maintaining a website or app is a significant fixed cost. Hosting fees, server costs, and IT support are essential for smooth operation;
• Marketing and Advertising: A large portion of e-commerce business costs is spent on digital marketing, including SEO, social media advertising, and paid search campaigns;
• Logistics and Fulfillment: Managing warehouses, packaging, and customer delivery is a significant variable cost, mainly as sales volumes fluctuate;
• Customer Service: Customer support costs, including chatbots, call centers, and email support, are key to maintaining relationships.

This is a mix of fixed and variable costs, but companies may optimize for cost efficiency by automating processes or outsourcing logistics.

2. SaaS (Software as a Service): SaaS businesses provide cloud-based software solutions on a subscription basis. Their Cost Structures are often streamlined, but can still involve significant expenditure:

• Software Development and Maintenance: The ongoing costs for software updates, bug fixes, and new feature development are fixed costs, requiring a significant investment;
• Cloud Hosting and Storage: Many SaaS companies rely on cloud infrastructure (like AWS or Google Cloud), which incurs both fixed and variable costs based on usage;
• Customer Acquisition: Marketing and sales efforts to attract new customers, especially through paid channels, can be expensive, especially in highly competitive markets;
• Support and Customer Success: Costs for providing customer support or success teams to onboard, retain, and troubleshoot for customers. This is a key driver for customer satisfaction and retention.

In this case, the SaaS model typically focuses on optimizing long-term customer value while balancing operational costs.

3. Manufacturing Company: A manufacturing business typically has a capital-intensive Cost Structure due to the physical nature of production. Here are the major cost components:

• Raw Materials: The variable cost of raw materials (e.g., steel, plastics, or fabrics) fluctuates based on production volume and supplier pricing;
• Labor Costs: This includes wages for production workers and staff overseeing the manufacturing process. These can be fixed (salaried staff) or variable (hourly workers);
• Machinery and Equipment: Purchasing and maintaining heavy machinery are significant fixed costs and depreciation over time;
• Energy Costs: Operating a factory can incur high utility costs, particularly for electricity, gas, or water;
• Logistics and Distribution: Similar to e-commerce, costs associated with shipping finished products to customers or retailers are variable.

Manufacturing companies often adopt a cost-driven model, focusing heavily on minimizing production costs to achieve competitive pricing.

4. Freelance or Consulting Business: For freelancers or consultants, the Cost Structure is generally less complex but still essential for financial planning. Their major costs may include:

• Marketing and Lead Generation: Freelancers often spend on personal branding, advertising, or platform fees (e.g., LinkedIn or Upwork) to generate leads;
• Software and Tools: Tools like design software, project management apps, or accounting software are essential and represent fixed costs;
• Travel and Client Meetings: Consultants might incur travel costs to visit clients or attend conferences. These are variable expenses;
• Education and Training: Staying updated with the latest industry skills requires attending courses or earning certifications, which are periodic fixed costs.

In this case, freelancers may aim to keep costs low, making them highly value-driven. They may focus on delivering premium services to justify higher pricing.

5. Retail Business: Traditional brick-and-mortar retail stores face significant fixed costs, including:

• Rent and Utilities: Renting physical space is a significant fixed cost for retail businesses. Utility bills such as electricity, heating, and water also add to this;
• Inventory Management: Costs for acquiring and storing inventory vary and depend on sales volume;
• Staffing: The payroll for store employees consists of fixed (managers) and variable (hourly employees) costs, with additional seasonal hiring when necessary;
• Point-of-Sale Systems: POS systems’ purchase, installation, and maintenance represent fixed costs for ensuring seamless transactions.

Retailers often deal with a high volume of variable costs, especially when handling inventory turnover and managing seasonal fluctuations.

6. Subscription Box Services: Subscription box businesses offer recurring delivery of products, often in a niche market. The major cost components include:

• Product Sourcing: Depending on the subscription type (e.g., food, beauty, lifestyle), the cost of sourcing products is a variable expense that fluctuates with box volume;
• Packaging and Shipping: Every subscription box requires packaging materials and delivery services, adding to variable costs;
• Marketing and Customer Retention: Paid advertising campaigns, influencer collaborations, and discounts to retain existing customers involve significant ongoing costs;
• Warehouse and Fulfillment: Storing and assembling boxes and managing returns add to the operational fixed costs.

These businesses focus on balancing fixed operational costs with the variable costs tied to the number of subscribers, which may fluctuate monthly.

Cost Driven Businesses vs Value Driven Businesses

Cost-driven business models focus on minimizing costs wherever possible. They seek, therefore, to create and maintain a cheaper structure by means of Value Propositions of smaller prices, using automation and outsourcing whenever possible. The goal is to have less expense to generate a more affordable final product.

However, it’s worth remembering that a business should only reduce its costs based on its internal expenses rather than in response to what its competition is doing. Anyone who opts for price warfare may face ruin in the marketplace. This is because if the company cannot manage costs by creating operational efficiency, the low price may become unsustainable. 

On the other hand, value-driven business models are less concerned with transaction costs and focus on creating Value Propositions. These value propositions usually have a high level of customization, developed according to the clients’ preferences. This is the case with luxury hotels, for example, which strive to create an experience for which customers are willing to pay dearly.

Cost structures can have the following characteristics:

• Fixed costs: in these structures, the business’s expenses are always the same, regardless of the production size. Costs are time-limited, as is the case with salaries and rentals. Value propositions focus on low prices, maximum automation, and extensive outsourcing.
• Variable costs: in these structures, the costs depend significantly on the production volume. For example, there are no variable costs if you do not produce. These costs arem therefore, sensitive to demand and difficult to predict, as they increase proportionally to the increase in labor and capital. They involve spending on services and raw materials, for example.
• Economies of scale: Here, the larger the volume of production, the lower the total cost per unit. Most large companies with a high production quota are characterized by this cost structure. This is because the total costs are divided by the quantity of articles produced, so the average cost per unit gets smaller.
  That is why a larger company generally has a lower unit cost than a small business. This saving is usually transferred to the final consumer, who is able to pay a lower price on the market.
• Economies of scope: in this structure, costs are reduced when the company invests in varied markets or a greater scope of operations. This is because different products share resources and processes.
  For example, the company already has an ongoing infrastructure with marketing, finance, and HR departments and can enjoy the same organization and only expand the scope, saving in the end.
  Scope economies offer several advantages, such as: design and product mix flexibility, faster response rate and shorter time to market changes, reduced waste, more accurate change and cycle prediction, more efficient use of software and hardware.
  In short, there is less risk in a business that sells more than one product and/or segments several markets, since even if the market falters, the company will have more alternatives to sustain itself as it rebalances its strategy.

Cost Structure Business Model Canvas

The Cost Structure in the Business Model Canvas consists of several key elements that help businesses identify and manage their expenses effectively. Here are the primary components:

1. Fixed Costs: Fixed costs are expenses that remain constant regardless of the business’s output level or sales. Common examples include:

• Rent or Lease Payments: Costs for office space, warehouses, or production facilities.
• Salaries and Wages: Fixed salaries for permanent employees, excluding variable commissions or bonuses.
• Insurance: Regular payments for liability, property, and health insurance.

2. Variable Costs: Variable costs fluctuate with the level of production or sales. These include:

• Raw Materials: Costs of inputs required for production, which increase with higher output.
• Direct Labor: Wages for workers that vary based on production levels, such as hourly wages for factory workers.
• Shipping and Distribution: Costs associated with delivering products to customers rise with increased sales volume.

3. Semi-Variable Costs: Semi-variable costs contain both fixed and variable components. For example:

• Utilities: A base fee (fixed) plus additional charges based on usage (variable).
• Sales Staff Compensation: A fixed salary combined with performance-based commissions.

4. Operational Costs: These are ongoing expenses necessary for the day-to-day functioning of the business, including:

• Marketing and Advertising: Costs incurred to promote the business and attract customers.
• Administrative Expenses: General overhead costs, such as office supplies, software subscriptions, and administrative salaries.

5. Capital Expenditures: Capital expenditures are one-time costs for long-term assets that support business operations, such as:

• Equipment Purchases: Costs for machinery, technology, or vehicles that contribute to production or service delivery.
• Facility Upgrades: Investments in renovating or expanding physical spaces.

6. Cost Drivers: Understanding cost drivers is essential for managing the Cost Structure. These are factors that cause costs to increase or decrease, such as:

• Production Volume: Higher production often leads to lower per-unit costs due to economies of scale.
• Market Demand: Fluctuating customer demand can impact variable costs significantly.

What to ask when creating a cost structure

WWhen doing a complete analysis of your business model, the time will come when you need to establish a Cost Structure that matches each of the previous blocks satisfactorily. To help you with this journey, you can ask yourself the following questions about your venture:

• What are the baseline costs that derive from my business model?
• Which Key Resources can be a heavy expense for the business?
• What Key Activities may incur high costs for the business?
• How do your Key Activities generate costs?
• Do these same Key Activities correspond to the Value Propositions chosen?
• When reconfiguring your business model, do costs continue to be fixed or become variable?
• Is your business more cost-oriented or value-oriented?

It is important to note that 90% of new businesses fail in their first three years because they cannot understand the costs required to develop their Value Propositions. However, when entrepreneurs can pinpoint their key resources, activities, and partners, costs become more straightforward to calculate.

Finally, your cost structure should be re-evaluated from time to time, just like the other blocks. This is the only way to ensure the long-term sustainability of your business.