The term cost structure refers to the relative proportion of and costs in an organization.

What is Meant by Cost Structure?

A cost structure means the types and relative proportions of fixed and variable costs incurred by the business. The concept can be explained in smaller units, such as by-product, service, customer, product line, division, or geographic region.

The cost structure is employed as a means to fix prices if you are using a cost-based pricing strategy. It also depicts areas in which costs can be reduced or at least have better control. Therefore, the cost structure is a management accounting concept and has no applicability to financial accounting.

Break Up of the Cost structure

One needs to identify every cost incurred in relation to a cost object to define the cost structure.

The fixed costs are the costs of those items that remain the same irrespective of the volume of goods and services. On the other hand, the variable costs are such costs which vary in proportion to the volume of goods or services.

The key elements of the cost structures are as follows:

1. Product cost structure

• *Fixed costs: *Direct labour and manufacturing overheads
• *Variable costs: *Direct materials, production supplies, commissions, and piece-rate wages

2. Product line cost structure

• *Fixed costs: *Administrative overheads, manufacturing overheads, and direct labour
• *Variable costs: *Direct materials, production supplies, and commissions

3. Customer cost structure

• *Fixed costs: *Administrative overheads for customer service and warranty claims
• *Variable costs: *Costs of goods and services sold to the customer, sales returns, and credits received

4. Service cost structure

• *Fixed costs: *Administrative overheads
• *Variable costs: *Staff wages, bonus, tax deducted at source, travel, and entertainment

Certain costs aforementioned can be tough to define. So you may need to complete an activity-based costing outline to closely assign costs to the cost structure of the given cost object.

Use Cases of Cost Structure in Business Models

The cost structure explains all costs incurred to make a business model functional. Such costs can be computed easily after determining key resources, activities, and partnerships. The structure can be either cost-driven or value-driven.

Cost-driven business models minimise costs wherever possible, often through a low price value proposition, maximum automation, and extensive outsourcing. Whereas, value-driven companies focus on a premium value proposition often with a high degree of personalised service.

Designer clothes, luxury hotels, and asset management fall into this category. Economies of scale and the economies of scope are some of the important characteristics of the cost structure.

In order to develop the cost structure of your business model, a company should consider the most vital costs to the business and establish hypotheses for these expenses. Both the fixed costs, such as the startup and acquisition costs and variable costs, such as the monthly operating costs must be accounted for. After gathering the necessary data using available resources, the company will be able to check out if it needs to pivot or proceed for proving its hypotheses.

What is Cost Structure?

Cost structure refers to the types and relative proportions of fixed and variable costs that a business incurs. The concept can be defined in smaller units, such as by product, service, product line, customer, division, or geographic region. Cost structure is used as a tool to determine prices, if you are using a cost-based pricing strategy, as well as to highlight areas in which costs might potentially be reduced or at least subjected to better control. Thus, the cost structure concept is a management accounting concept; it has no applicability to financial accounting.

Cost Structures of Cost Objects

To define a cost structure, you need to define every cost incurred in relation to a cost object. The following bullet points highlight key elements of the cost structures of various cost objects:

• Product cost structure

  • Fixed costs. Direct labor, manufacturing overhead

  • Variable costs. Direct materials, commissions, production supplies, piece rate wages

• Service cost structure

  • Fixed costs. Administrative overhead

  • Variable costs. Staff wages, bonuses, payroll taxes, travel and entertainment

• Product line cost structure

  • Fixed costs. Administrative overhead, manufacturing overhead, direct labor

  • Variable costs. Direct materials, commissions, production supplies

• Customer cost structure

  • Fixed costs. Administrative overhead for customer service, warranty claims

  • Variable costs. Costs of products and services sold to the customer, product returns, credits taken, early payment discounts taken

Some of the preceding costs can be difficult to define, so you may need to implement an activity-based costing project to more closely assign costs to the cost structure of the cost object in question.

How to Alter a Cost Structure

You can alter the competitive posture of a business by altering its cost structure, not only in total, but between its fixed and variable cost components. For example, you could outsource the functions of a department to a supplier who is willing to bill the company based on usage levels. By doing so, you are eliminating a fixed cost in favor of a variable cost, which means that the company now has a lower break even point, so that it can still earn a profit at lower sales levels. This would be quite useful when a business has a history of experiencing sharp declines in its sales levels.

The Impact of Capacity Levels on Cost Structure

A knowledge of the capacity levels associated with the existing fixed cost structure can also allow a business to increase its profits by lowering prices sufficiently to maximize the utilization of a fixed cost item. For example, if a company has spent $100,000 on a high-capacity automated machine and it is currently only being utilized 10% of the time, a reasonable action would be to obtain more work to increase the amount of cash earned from that machine, even at prices that might normally be considered low. This type of pricing behavior is only possible if you have a detailed knowledge of the cost structure of a business.

What does cost structure mean?

Which term refers the the relative proportion of fixed and variable costs in an organization?

Is the relative percentage in which a company sells its multiple products?

When a greater proportion of costs are fixed costs then?