Cost Structure in the Business Model

The Cost Structure element of a Business Model outlines all the costs and
expenses that a business will incur to operate effectively. It includes the
costs associated with the Key Resources, Key Activities, and Key Partnerships
required to deliver the value proposition, reach customers, maintain
relationships, and generate revenue.

Understanding the Cost Structure helps businesses manage their finances,

optimize efficiency, and ensure profitability. For students, identifying the cost
structure helps them anticipate expenses and think critically about how to
sustain and scale their business.

Why the Cost Structure is Important:

1. Profitability: Knowing the cost structure allows a business to determine its

breakeven point and profitability. It helps in setting prices and understanding
the minimum revenue needed to cover costs.

2. Financial Planning: The cost structure is essential for budgeting and

financial planning. It ensures that businesses allocate resources wisely and
do not overspend in nonessential areas.

3. Cost Optimization: By analyzing the cost structure, businesses can identify

areas where they can cut costs or become more efficient. It can lead to
improvements like reducing waste, optimizing supply chains, or automating
processes.

4. Sustainability: A business with a wellunderstood and manageable cost

structure can sustain itself even during periods of low revenue. If costs are
too high, especially in relation to revenue, the business model may not be
sustainable in the long term.

Types of Cost Structures

1. Cost-Driven:
In a costdriven business model, the primary focus is on minimizing costs
wherever possible, often by using lowcost resources, lean operations,
automation, and outsourcing.
Example: Discount retailers like S & R focus on offering the lowest prices by
optimizing supply chains, negotiating better deals with suppliers, and
keeping overhead costs low.

2. Value-Driven:
In a value-driven business model, the business is more focused on providing
highquality, unique value propositions, and thus, may incur higher costs.
These businesses often focus on premium products, exceptional customer
service, or highly personalized experiences.
Example: Luxury brands like Louis Vuitton or Apple focus more on creating
highend, innovative products and providing toptier customer experiences,
which justifies their higher costs.

Types of Costs to Consider

1. Fixed Costs:
These are costs that remain constant regardless of the volume of goods or
services produced or sold. Fixed costs include expenses that do not fluctuate
with business activity.
Examples: Rent, salaries of permanent employees, utilities, loan repayments,
and insurance.

2. Variable Costs:
These are costs that change directly with the level of production or sales.
The more a business produces or sells, the higher its variable costs.
Examples: Raw materials, packaging, shipping costs, and commissionbased
wages.

Key Elements that Drive Costs

1. Value Proposition
Value Proposition is closely linked to the Cost Structure because the type of
value a business offers to its customers often determines the kinds of
resources, activities, and partnerships required—thus influencing costs.

How the Value Proposition can impact the Cost Structure:

A. Cost-Driven vs. Value-Driven
If your Value Proposition is focused on lowcost offerings (such as affordable
products for costconscious customers), your business will likely adopt a
costdriven structure, where minimizing expenses is a priority. This might
involve outsourcing, automation, and using lowcost materials.
Example: A discount airline’s value proposition might focus on offering the
cheapest flights possible. Therefore, its cost structure will emphasize
costcutting measures like using a single type of aircraft, offering minimal
inflight services, and having flexible staff.
On the other hand, if your Value Proposition emphasizes quality, luxury, or
unique features, your business will likely adopt a valuedriven structure. This
often incurs higher costs, as more premium materials, specialized labor, and
extensive marketing might be needed to support the offering.
Example: A luxury car brand focuses on highquality materials, advanced
technology, and a superior customer experience, which leads to a higher
cost structure (e.g., highend manufacturing processes, research and
development, and premium materials).
B. Required Resources and Activities
A company’s Key Resources and Key Activities are tied to the value it
delivers. These resources and activities directly affect the cost structure.
Example: If your value proposition is to provide fast delivery, you’ll need to
invest in a robust logistics system, which will increase your deliveryrelated
costs.

A business offering a highquality or unique product might need specialized

equipment, highly skilled labor, or intellectual property, all of which will
increase fixed and variable costs.
Example: A startup coffee shop promising ethically sourced, premium coffee
will incur higher sourcing costs due to the need for higherquality beans,
relationships with ethical suppliers, and potentially more skilled baristas.

C. Customer Expectations and Costs

The value promised to customers will often come with certain expectations
around service, quality, or convenience, and fulfilling these expectations can
generate additional costs.
Example: If a business offers a value proposition based on exceptional
customer service (e.g., personalized attention or 24/7 support), the business
will need to account for higher staffing costs or technological infrastructure
to manage these customer interactions effectively.

D. Innovative Value Propositions and Cost Implications

Businesses with innovative value propositions (e.g., disruptive products, new
technologies) may have significant upfront costs related to research and
development (R&D), prototyping, and market testing.
Example: A tech startup offering a cuttingedge app may have to bear high
R&D costs initially to develop and refine the technology before generating
revenue.

E. Customization and Flexibility

Businesses that offer highly customized products or services as part of their
value proposition might face higher costs related to flexible production
processes, specialized customer support, or unique supply chains.
Example: A company offering custommade furniture will incur higher costs
for materials, labor, and delivery compared to a massproduction furniture
company, due to the bespoke nature of the product.

When considering the Value Proposition in the Cost Structure of a business

model, the following guide questions can help analyze how value proposition
impacts the costs their business will incur:

Guide Questions:
1. What key resources are required to deliver your value proposition?
Does your value proposition rely on highquality materials, specialized
technology, intellectual property, or skilled labor?
Example: If your value proposition is "offering premium, ethically sourced
coffee," do you need to source more expensive raw materials like highquality
coffee beans from fairtrade farms?

2. What key activities are necessary to deliver your value proposition?

Are there significant costs associated with production, customer service, or
research and development (R&D) to maintain the value proposition?
Example: If your value proposition promises fast delivery, do you need to
invest in a sophisticated logistics network to ensure quick fulfillment?

3. How does your value proposition influence your channel costs?

Does delivering your value proposition require specific channels (e.g.,
physical stores, online platforms, distributors) that increase costs?
Example: If your value proposition is about providing a personalized instore
experience, you’ll likely face higher costs in rent, staffing, and customer
engagement at a physical location.

4. What customer expectations does your value proposition create, and how
do these affect costs?
Does your value proposition create expectations for highquality customer
service, unique experiences, or premium packaging that will drive up costs?
Example: If your value proposition includes luxury packaging or personalized
customer support, how much will those elements cost to provide
consistently?

5. How do you ensure the value proposition is sustainable in terms of cost?

Are the resources and activities required to deliver your value proposition
affordable and scalable as your business grows?
Example: If you are offering lowcost, highquality goods, can you maintain
this balance without incurring losses as demand increases?

6. Does your value proposition involve any partnerships that impact the cost
structure?
Do you need to work with key partners (e.g., suppliers, distributors,
technology providers) to deliver the value proposition? How much do these
partnerships cost?
Example: If your value proposition is to provide ecofriendly products, do you
need to partner with suppliers who offer sustainable materials, and how does
that impact your costs?

7. Is your value proposition costdriven or valuedriven?

Are you focusing on minimizing costs (costdriven) or on providing premium
features and experiences that justify higher costs (valuedriven)?
Example: If your value proposition is about offering luxury goods, you’ll likely
have a valuedriven cost structure with high investments in materials,
branding, and customer experience.

8. How do economies of scale or scope affect the cost of delivering your

value proposition?
Can you reduce costs by producing more (economies of scale) or offering a
broader range of products using the same resources (economies of scope)?
Example: If your value proposition includes offering a wide variety of
products, will that variety help spread the costs of production and
distribution?

9. How does your value proposition affect variable and fixed costs?
Does your value proposition influence whether most of your costs are fixed
(e.g., equipment, salaries) or variable (e.g., materials, shipping)?
Example: If your value proposition promises personalized products, your
variable costs (like materials and labor) may be higher due to customization
requirements.

The Value Proposition plays a critical role in determining a business’s Cost

Structure because it defines what a business needs to do (or spend) to
deliver on its promises to customers. A costdriven business model focuses on
minimizing costs to offer low prices, while a valuedriven business model may
incur higher costs to provide premium, innovative, or highly customized
offerings.

2. Channel
Channel is an important factor to consider when developing the Cost
Structureof a business model. The Channel represents the means through
which a business delivers its value proposition to its customers, whether it’s
through direct sales, online platforms, retail stores, or distribution partners.
Different channels incur different types of costs, which need to be factored
into the overall cost structure.

How Channels Impact the Cost Structure:

1. Physical Channels vs. Digital Channels

Physical Channels (such as retail stores, direct sales, or thirdparty
distributors) often have higher operational and logistical costs, including
rent, utilities, inventory management, and staffing.
Example: A retail clothing store will have to pay rent for a physical space,
salaries for staff, utilities, and inventory costs. All of these expenses
contribute significantly to the cost structure.
Digital Channels (such as ecommerce platforms or mobile apps) may have
lower physical overhead costs but still require investments in technology,
platform maintenance, and online marketing. Costs can also arise from
thirdparty platforms, such as commission fees to Amazon, Shopify, or other
online marketplaces.
Example: An online store selling the same clothes will save on rent and
physical staff but may need to spend more on website development, hosting,
payment gateways, and digital marketing to drive traffic.

2. Distribution Costs
The logistics involved in delivering products or services through different
channels can have a significant impact on costs. For example, businesses
with physical products will need to account for shipping, warehousing, and
distribution expenses.
Example: A coffee subscription service will incur costs related to packaging,
shipping, and managing inventory, which can vary depending on whether the
distribution is local or international.

3. Sales Channel Costs

Depending on the sales channel, costs can vary widely:
Direct Sales Channels: Selling directly to customers through owned channels
(e.g., a business’s own retail store or website) may involve higher upfront
costs but no intermediary fees. However, marketing and maintaining
customer relationships require significant investments.
Indirect Sales Channels: Selling through thirdparty distributors, retailers, or
marketplaces involves giving up a margin to intermediaries, either through
commissions or discounted pricing.
Example: A business selling products through a thirdparty retailer like
Walmart or Amazon will need to account for commissions, distribution fees,
or wholesale pricing models, all of which affect the cost structure.

4. Customer Support and AfterSales Costs

Depending on the channel, customer support and aftersales services can
also add to costs. Businesses selling through online or physical channels
need to manage customer queries, returns, and complaints, which requires
staffing, training, and technology systems.
Example: An online business offering 24/7 customer support through chat or
phone will incur additional staffing and software costs to handle inquiries
efficiently.

5. Marketing and Promotion Costs

Reaching customers through various channels requires significant marketing
and promotional efforts, and these expenses should be included in the cost
structure.
Example: A business selling through its own ecommerce website may need
to invest heavily in digital advertising (e.g., Google Ads, social media
marketing) to drive traffic, whereas a business selling through physical retail
stores might focus more on instore promotions, events, and physical
marketing materials.

6. ChannelSpecific Technology and Maintenance Costs

For businesses relying on digital channels, maintaining websites, mobile
apps, or thirdparty integrations incurs ongoing costs related to platform
development, security, and performance optimization.
Example: A company using an ecommerce platform will incur recurring
expenses for website maintenance, payment processing, and technology
upgrades. These costs will vary depending on the complexity of the platform
and whether the company uses thirdparty services.

Guide Questions for Considering Channels in the Cost Structure:

To guide you in identifying how Channels affect the Cost Structure, here are
some questions they can ask:

A. What are the costs associated with each sales or distribution channel?
Are you using physical stores, online platforms, or thirdparty distributors?
What are the fixed and variable costs of each?

B. How do your channels affect logistics and delivery costs?

If you’re selling physical products, how much will you spend on shipping,
packaging, and warehousing?

C. What marketing or promotional costs are needed to drive traffic to your

channels?
Are you investing in social media advertising, traditional marketing, or
instore promotions to bring customers to your channel?

D. Do thirdparty channels (retailers, marketplaces) require commissions or

discounted pricing?
If you’re using platforms like Amazon, Shopify, or retail partners, how much
of your revenue will go to those intermediaries?

E. What customer support costs arise from your channels?

Are you offering live support, return policies, or warranty services through
specific channels? What’s the cost of maintaining those services?

F. What technology and maintenance costs are needed to support digital

channels?
For online businesses, what will you spend on website or app development,
payment processing, or data security?
Example: Coffee Shop Startup
If a startup coffee shop uses multiple channels to sell its products, such as a
physical café, online orders for delivery, and wholesale distribution to local
grocery stores, its Cost Structure would need to account for:

Physical Channel (Café):

Rent, utilities, salaries for staff, equipment for making coffee, and instore
marketing costs.

Online Channel (Delivery):

Website development and maintenance costs, digital marketing (social
media ads), payment gateway fees, and delivery logistics (packaging, courier
services).

Channels are an essential component in determining the Cost Structure of a

business model. Different channels—whether physical or digital, direct or
indirect—bring specific costs related to logistics, customer support,
marketing, and technology. By carefully considering the costs associated with
each channel, businesses can optimize their operations and ensure their
value proposition is delivered efficiently and profitably.

3. Key Resources:
The resources a business requires can drive costs. For example, physical
assets like machinery, technology infrastructure, or even human resources
like skilled laborers can significantly impact a business’s cost structure.
Example: A tech company with a focus on innovation may have high costs
associated with R&D and skilled developers.

Key Resources and Cost Structure:

1. What essential resources are needed to deliver your value proposition?

Are these resources physical (e.g., raw materials, equipment), intellectual
(e.g., patents, designs), or human (e.g., skilled labor, expertise)?
Example: If your business relies on advanced technology, how much will it
cost to develop, maintain, or acquire that technology?

2. Which resources incur the most significant costs in your business model?
Are there resources that have high fixed or variable costs, such as expensive
machinery, specialized staff, or inventory?
Example: A coffee shop’s key resource may be premium coffee beans, and
the costs for sourcing these beans will affect the cost structure.

3. How do the costs of these resources scale as your business grows?

Will the cost of key resources increase or decrease as your business
expands? Can you achieve cost savings through bulk purchasing or more
efficient processes?
Example: If your business grows, can you negotiate better deals with
suppliers for your raw materials?

4. How much will maintaining these key resources cost over time?
What are the ongoing costs related to maintaining or upgrading key
resources like technology, equipment, or intellectual property?
Example: Does your business need to regularly update its software systems
or replace outdated equipment?

4. Key Activities:
The primary activities a business must perform to deliver its value
proposition also incur costs. This could include production, marketing, sales,
and delivery.
Example: A manufacturing company’s production processes will lead to high
material and labor costs, while a marketingheavy business will face high
advertising costs.

Key Activities and Cost Structure:

A. What are the core activities needed to deliver your value proposition?
Are these activities related to production, marketing, distribution, customer
support, or other areas?
Example: If your coffee shop promises fast delivery, your key activity might
be managing a robust logistics network, which incurs delivery and
technology costs.

B. Which key activities drive the most costs?

Are there particular activities that consume the most financial resources,
such as manufacturing, research and development (R&D), or marketing?
Example: If your value proposition includes heavy customization of products,
will the production process be more expensive due to specialized labor or
tools?

C. How do your key activities influence fixed and variable costs?

Are your core activities creating high fixed costs (e.g., factory operations,
salaried employees) or variable costs (e.g., materials, commissions)?
Example: Does hiring more staff during peak business times increase your
variable costs?

D. How can these activities be optimized or outsourced to manage costs?

Can some activities be done more efficiently or outsourced to third parties at
a lower cost without compromising the value proposition?
Example: Can your marketing be outsourced to a thirdparty agency to reduce
inhouse marketing costs?
5. Key Partnerships:
Partnerships can affect costs in different ways. Outsourcing certain activities
or resources can reduce costs, but relying on third parties can sometimes
create dependency, leading to higher costs if partnerships aren't managed
effectively.
Example: A coffee shop that outsources its pastry production to a local
bakery may save on labor and equipment costs but needs to account for the
cost of purchasing pastries from the partner.

Key Partnerships and Cost Structure:

A. Which key partners are necessary to deliver your value proposition?
Do you rely on suppliers, distributors, technology providers, or other
strategic partnerships to operate your business?
Example: A coffee shop may rely on partnerships with ethically sourced
coffee bean suppliers, and these partnerships will affect sourcing costs.

B. What costs are associated with maintaining these partnerships?

Are there costs related to contractual agreements, commissions, or shared
revenue with partners?
Example: If your business partners with a delivery service for online orders,
what are the fees or commissions charged by that service?

C. Are there any costsaving opportunities through partnerships?

Can you reduce costs by forming partnerships that offer bulk purchasing,
shared resources, or comarketing opportunities?
Example: Can partnering with a local bakery reduce the cost of sourcing
baked goods by combining supply orders?

D. How do partnership agreements impact your fixed and variable costs?

Are your partnerships creating fixed costs (e.g., longterm contracts, licensing
fees) or variable costs (e.g., pertransaction commissions, payasyougo
services)?
Example: Does a longterm supply agreement lock you into fixed costs that
could become expensive if the market price drops?

E. How dependent is your business on these partnerships, and what are the
financial risks?
If a key partner fails to deliver or increases costs, how will it impact your
overall cost structure? What contingency plans do you have?
Example: If a supplier raises prices, can you switch to an alternative partner,
or will that disrupt your operations?

Guide Questions to Develop the Cost Structure

A. What are the most important costs inherent in your business model?
 What are the main areas where your business will spend money to
operate effectively?

B. Which Key Resources are most expensive?

Are the costs primarily driven by physical resources (e.g., equipment,
raw materials), intellectual resources (e.g., patents, brand
development), or human resources (e.g., salaries for skilled workers)?

C. Which Key Activities are most expensive?

Which activities (production, marketing, customer service, etc.) require
the most investment?

D. What fixed and variable costs are involved in your business?

How much of your expenses are fixed (e.g., rent, salaries) versus
variable (e.g., cost of materials, sales commissions)?

E. Are you focused on reducing costs (costdriven) or on adding value

(valuedriven)?
Is your business model aimed at being the cheapest in the market, or
do you focus more on providing premium value with higher costs?