SLC | S21W6 | Costs for Entrepreneurs - Cost structure
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A cost structure refers to the different expenditures and costs encountered by a business in the course of producing and delivering its products or services. It is an exhaustive framework that outlines every cost connected with running a business, including fixed costs, variable costs, direct costs, and indirect costs.
Importance of Cost Structure to Entrepreneurs
- Pricing Strategy: Understanding the cost structure enables entrepreneurs to determine the best price for their products or services, making sure they cover costs as well as generate profits.
- Cost Control and Reduction: Spotting areas of high costs helps entrepreneurs put cost-saving measures into practice, lowering expenditures and enhancing profitability.
- Investment Decisions: An explicit understanding of the cost structure enables entrepreneurs to make knowledge-based decisions about investments, like the purchase of new equipment or employing additional staff.
- Break-Even Analysis: Understanding the cost structure permits entrepreneurs to calculate their break-even point, which is necessary for determining when their business will become lucrative.
- Competitive Advantage: The knowledge of the cost structure can assist entrepreneurs spot areas where they can acquire a competitive advantage by mitigating costs or enhancing efficiency.
- *Cash Flow Management: An explicit comprehension of the cost structure enables entrepreneurs to effectively manage their cash flow, making sure they have adequate funds to meet their financial commitments.
- Scaling and Growth: The cost structure of a business may change as the business grows. Understanding these changes is necessary for entrepreneurs to make knowledge-based decisions about scaling and growth.
In summary, the understanding of cost structure is important to entrepreneurs in making knowledge-based decisions about their business, managing costs effectively, as well as propelling growth and profitability.
The cost structure methods explained in the class are Incited by Cost methods and Incited by Value methods.
Below are some business examples that use the "Incited by Costs" ( also known as Cost-Plus) and "Incited by Value" ( also referred to as Value-Based) cost structure methods:
Incited by Costs (Cost-Plus) Examples
- Construction Companies: Construction companies usually make use of the cost-plus pricing method, in which they calculate their costs (materials, labor, overhead) and add a markup for determining the final price.
- Manufacturing Companies: Most manufacturing companies, such as those in the automotive or aerospace industries, make use of cost-plus pricing to make sure they cover their high production costs as well as generate a profit.
- Accounting Firms: Accounting firms usually utilize cost-plus pricing, in which they calculate their costs (time, expertise, overhead) and add a markup in determining the conclusive price for their services.
Incited by Value (Value-Based) Examples
- Software Companies: Software companies such as Microsoft or Salesforce usually make use of value-based pricing, in which they charge customers judging by the perceived value of their software.*
- Luxury Fashion Brands: Luxury fashion brands such as Gucci or Louis Vuitton employ value-based pricing, in which they charge high prices for their products judging by the quality, reputation, and exclusivity of their brand.
- Consulting Firms: Management consulting firms such as McKinsey or BCG usually utilize value-based pricing, in which they charge clients base upon the value they generate through their consulting services.
Reasons for my answer
- Cost-incited pricing is usually utilized in industries that have high production costs or in which costs are easily quantifiable.
- Value-incited pricing is usually employed in industries in which there is a high perception of the value of the product or service and customers are acquiescent to pay a premium.
- Companies may opt for cost-plus pricing if they want to make sure they cover their costs and create a profit, while value-based pricing is usually employed if companies need to maximize their net sales or revenue as well as profitability.
The elements of a cost structure can be classified into a number of different components. Here are the key elements of a cost structure, in addition to examples:
1. Fixed Costs
- Rent and Utilities: Rental cost or the cost of acquiring a building, as well as payment for utilities like electricity, gas, and water.
Example: A retail shop pays $3,500 per month in rent and utilities. - Salaries and Wages: The cost of hiring staff, such as their salaries, wages, and benefits.
Example: A software company pays its software engineer a regular salary of $150,000 per year. - Depreciation and Amortization: The depreciating or amortizing cost of assets like vehicles, equipment, and intangible assets.
Example: A manufacturing company depreciates its machinery over 4 years, leading to an annual depreciation expenditure of $40,000.
2. Variable Costs
- Raw Materials and Supplies: The cost of buying raw materials as well as supplies utilized in production.
Example: A bakery buys flour, yeast, and sugar at $1,100 per week. - Labor Costs: The cost of labor utilized in production, such as overtime as well as temporary labor.
Example: A construction company pays its laborers $30 per hour, leading to a sum labor cost of $90,000 per week. - Marketing and Advertising: The cost of advertisement and promotion of products or services.
Example: An e-commerce business pays out $4,000 per month on Google Ads as well as social media advertising.
3. Semi-Variable Costs
- Utilities: The cost of utilities like electricity, gas, and water, which can differ based on usage.
Example: A cafeteria pays $1,000 per month in utilities, which can differ based on the number of customers. - Maintenance and Repairs: The cost of maintaining and repairing machines as well as assets.
Example: A manufacturing company pays out $2,000 per month on repairs and maintenance of its machinery.
Other Costs
- Taxes and Licenses: The cost of payment for taxes and licenses for operating a business.
Example: A retail shop pays $5,000 annually in sales taxes and licenses. - Insurance: The cost of insuring a company against hazards like liability, damage, property, as well as business interruption.
Example: A production company pays annual $8,000 in insurance premiums.
These are only a few examples of the elements of a cost structure. The specific costs and categories will differ based on the business as well as industry.
Fixed Costs
- Rent and Utilities: $1,200 per month
- Equipment and Machinery: $4,800 (amortized over 4 years)
- Insurance: $400 per month
- Salaries and Wages: $4,000 per month (for 2 employees)
Total Fixed Costs: $10,400 per month
Variable Costs
- Raw Materials and Supplies: $100 per day (flour, eggs, sugar, etc.)
- Labor Costs: $120 per day (extra labor costs for production)
- Packaging and Delivery: $130 per day
Total Variable Costs: $350 per day
Semi-Variable Costs
- Utilities (variable portion): $40 per day
- Maintenance and Repairs: $80 per month
Total Semi-Variable Costs: $120 per month
Total Costs
- Total Fixed Costs: $10,400 per month
- Total Variable Costs: $350 per day x 30 days = $10,500 per month
- *Total Semi-Variable Costs: $120 per month
Total Costs: $21,020 per month
Revenue and Profit
- Revenue: 5 cakes per day x $45 per cake x 30 days = $6,750 per month
- Desired Profit Margin: 25%
- Desired Profit: $6,750 per month x 0.25 = $1,687.5 per month
A big thanks to you for your time and engaging with my blog. I am inviting @eveetim, @pretty-precious, and @bela90
Great job! Nice content and detailed explanation. Thank you for the invitation, I'm still learning this.
You are welcome, hope you join soon
Greetings @hisgeneral
1.- You have shared the concept and importance of the cost structure for the enterprise, highlighting that it allows to control the resources invested in a productive process.
2.- You have mentioned acceptable examples of companies that adjust to the cost structure methods. You have provided the description of each of these methods, allowing the analysis of all the costs involved.
3.- You have presented the elements of the cost structure, with their respective examples; these allow us to identify the expenses in each functional area of the company.
4.- You have developed the proposed exercise acceptably, performing in detail each of the calculations. We would have liked to see a little more analysis of the results.
Thanks for joining the contest