The Cost Structure describes all costs incurred to operate a business model. Every business model creates costs. The question is whether they are understood, justified and managed.
In our experience, they usually are not.
Two Cost Philosophies: Cost-Driven vs. Value-Driven
Cost-Driven
The focus is on minimising cost wherever possible. Budget airlines. Discount retailers. The value proposition is partly built on low price. Margins are thin and volume does the work.
Value-Driven
The focus is on creating maximum value, even at higher cost. Premium hotels. Bespoke consulting firms. The customer pays for the experience, not the underlying cost.
Most businesses sit somewhere between these two extremes. The problem is when they have not decided where they sit. Trying to be both usually means being neither.
Fixed vs. Variable Costs: Know the Difference
Fixed costs stay constant regardless of output:
- Salaries, rent, software licences, insurance
Variable costs scale with output:
- Materials, transaction fees, delivery costs, cloud computing beyond a baseline
This split matters for pricing decisions. A business with mostly fixed costs has very different margin dynamics than one that is mostly variable.
Economies of Scale and Scope
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Economies of scale: costs fall per unit as production volume increases
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Economies of scope: costs fall when producing multiple products together is cheaper than separately
Both are worth modelling explicitly when you are planning growth.
Three Common Cost Structure Mistakes
1. Underestimating fixed costs. Personnel costs are almost always higher than people expect when you factor in benefits and management time.
2. Confusing investment with cost. R&D, brand building and infrastructure generate future value. Treat them differently in your analysis.
3. Not reviewing regularly. Cost structures drift. Something that made sense two years ago may no longer. Review yours at least annually.
Questions to Explore with Clients
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What are your biggest cost categories, and are they directly linked to value creation?
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What proportion of your costs are fixed vs. variable?
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If you needed to reduce costs by 20%, where would you start?
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What costs could you reduce by partnering with someone else or adopting a different technology?
Now put it into practice.
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