In this last section, I’ll walk you through the cost structure building block of the business model canvas. I’ll explain the different types of costs and show you the key questions every entrepreneur must be able to confidently respond to when analysing the business model.
You will learn about the different types of cost structure: fixed and variable costs and they can have benefits through economies of scale or economies of scope.
Table of Contents
The Business Model Canvas cost structure describes the costs that business occurs through its operations. These include employees, infrastructure, costs associated with all activities as well as sourcing through key partnerships.
The cost structure building block presents all the costs that you incur as a business. 90% of new businesses fail in the first 3 years because they fail to understand their costs or what it will take to create the goods and services they have promised in their value propositions.
In another study, CB Insights looked at the post-mortems of 101 startups to compile a list of the Top 20 Reasons Startups Fail. The number two position ‘ran out of cash’.
When reviewing the cost structure block you need to recognise where your main costs will be:
When doing an analysis of your business model, it is vital to ask the following questions when filling in the Cost Structure building block of the business model canvas:
This kind of approach concentrates on reducing costs as much as possible. This can be done through outsourcing and automating wherever possible.
Examples include:
This is a more value centred approach which focuses on maximising worth for the customer. This approach focuses on a highly personalised and tailored service that really focuses on minimising Customer Pains and increasing their Gains.
Examples include:
How costs work depends on their characteristics. It’s important to appreciate the difference between fixed costs, variable costs and ultimately being able to calculate your break-even point.
These costs are usually a fixed percentage of your overall costs. While they do change, often incrementally they remain fairly staple.
Examples include:
These types of costs change depending on the number of goods and services produced by a business. These include things like raw materials, shipping costs web hosting servers.
Here are a number of examples of variable costs, all in a production setting:
Economies of Scope are savings generated when the cost of producing a range of products together is cheaper than manufacturing them individually. For example, several products may share the same marketing activities or Distribution Channels.
One of the advantages of big organizations is that they benefit from the fall in costs with higher volumes which spread fixed costs more thinly making the cost per unit fall dramatically; hence the average cost per unit is reduced. As a result, a bigger company will have a lower cost per unit output than a smaller company. An example is when a big company buys and gets a much lower cost than a small business.
Economies of scope refer to the reduction of costs when a business invests in multiple markets or a larger scope of operations. The average cost of production decreases if a company opts to increase the number of goods it produces.
Economies of scope based on product diversification are only achieved if the different products have common processes or share the use of some resource. Hence spending on marketing the products or distribution channels may lessen per unit if both products require similar marketing efforts or use the same distribution channel.
Economies of scope have multiple advantages for the business:
A common mistake is to underestimate the day to day expenses or odd things that crop up that you haven’t thought about. These might be legal costs e.g. filing patents…it could be anything. The fact is that most entrepreneurs under-estimate daily expenses as well.
The solution is to allow for an overall contingency percentage in your budgeting. A typical figure of ten per cent will suffice until you do the detailed budget planning.
Within a market that has a dominant business model companies often have similar partners, activities and costs associated with sales and marketing. By looking at their publicly available reports you can get a good sense of what costs they incur as well as the costs associated with sales and marketing.
Another benefit of this is to use this information to then consider how you can change the business model, change the cost structure and therefore produce a more sustainable competitive advantage.
Doing your research will eliminate the risks and help to produce a successful business model design.