COST STRUCTURE

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What is the CANVAS cost structure?

The cost structure is one of the nine blocks that make up the Business Model Canvas, a tool used to describe and analyse a company's business model. The cost structure refers to the expenses that a company must incur in order to operate and generate revenue. The The objective of the cost structure is to identify and understand all costs relevant to the business, so that informed decisions can be made on how to optimise and reduce them as far as possible. This allows the company to maximise its profitability and maintain a competitive advantage in the market. The cost structure includes all costs associated with operating the business, from the direct costs of production or purchasing materials, to indirect costs such as office rent, salaries, utilities, marketing and advertising, among others. These costs can be fixed or variable, depending on whether they are linked to the production of a specific good or service or whether they are necessary for the day-to-day running of the business.

It is important to note that the cost structure must be aligned with the other blocks of the Business Model Canvas, especially the value proposition and distribution channels. The company must be able to deliver its value proposition in a profitable and sustainable way, ensuring that its costs do not negatively affect its ability to compete in the market. In short, the cost structure, is a key part of any company's business model and must be continuously analysed and optimised to ensure the profitability and sustainability of the business.

Why is it important that you have the right cost structure for each stage of your start-up?

Establishing an appropriate cost structure at each stage of setting up a business allows you not only to minimise risks and maximise profits, but also to negotiate more effectively with suppliers. If you know your available costs and budget at each stage, you will have a better understanding of what you can afford to pay for products and services from suppliers, and you will be in a better position to negotiate favourable prices and terms. Moreover, if you are willing to be flexible in terms of the suppliers you use at different stages, you can take better advantage of opportunities to reduce costs and maximise profits. In general, the cost structure is a key part of financial planning when setting up a business and can make the difference between success and failure.

Having more fixed costs than variable costs means taking on more risk because your structure will be less flexible and less adaptable to declines in customer sales. Taking on more risk means that your structure will be less flexible and less adaptable to declines in customer sales. Post can be more risky for a company. This is because fixed costs are those costs that do not vary according to the company's production or sales and must therefore be covered regardless of the company's level of activity. If the company has a drop in sales or production, it will have difficulties in covering these fixed costs, which can lead to financial problems and jeopardise the survival of the company. On the other hand, variable costs are those costs that are directly related to the production or sales of the company and therefore increase or decrease depending on the level of activity of the company. This means that if the company has a drop in sales or production, it will also have a reduction in variable costs, allowing it to adjust its costs and maintain profitability. It is therefore important that, a company has an appropriate cost structure at each stage, with an appropriate mix of fixed and variable costs at all times, in order to be able to adapt to changes in the market and to reduce financial risk.

In the early stages of a new venture, where uncertainty is greatest, it is better to have variable costs and reduce fixed costs. In the early stages of a new business, it is advisable to have a more flexible cost structure based on variable costs rather than fixed costs, as this allows the business to adapt quickly to market needs and adjust its budget accordingly. Fixed costs, on the other hand, are more difficult to reduce or adjust in case the company experiences a decrease in revenues or a financial crisis. However, it is also important to have a proper balance between fixed and variable costs to ensure the long-term financial stability of the company. When I've already passed milestones, such as your sales have exceeded the break-even point (+) is when I can negotiate with suppliers a change from variable to fixed with the aim of earning more money for the effect leverage (+). Once the break-even point is reached, or once we have passed milestones that allow us to reduce uncertainty, we can have more room to negotiate with suppliers and seek agreements that allow us to transform variable costs into fixed costs, in order to increase profits and take advantage of the leverage effect.

It is better to start the business with all variable costs and move to fixed costs as milestones are reached. In general, In the early stages of a business, it is advisable to have more variable costs than fixed costs, as this allows for greater flexibility and adaptability to changes in the market and in the demand for the product or service. In addition, variable costs can be adjusted according to sales and do not become a fixed burden in times of downturn. However, Once a certain level of stability is reached and certain milestones are passed, it is possible to consider shifting some variable costs to fixed costs in order to take advantage of the leverage effect and reduce unit costs. It is important to carry out a detailed analysis of costs and expected sales before making this decision, as there is a risk of high fixed costs at times of low activity. In short, it is recommended, start with more variable costs and move to fixed costs as the company stabilises and certain milestones are reached, but always with a detailed and prudent analysis of the company's financial situation and the market in which it operates.

You have to change the cost structure as you go along with the company, I start with a very flexible and low risk structure which means less money and I change to a more fixed structure with more risks but which allows you to earn more money. It makes sense in the creation of a new company to adjust the cost structure according to the milestones reached and the growth of the company. At the beginning, it is advisable to have a more flexible and variable cost structure to minimise risks and ensure financial viability in the early stages. As milestones are reached and the business consolidates, the option of shifting some variable costs to fixed costs can be considered, which can generate higher profits due to the leverage effect. It is a mistake to think that costs are always fixed or variable, the power to change them from variable to fixed and vice versa lies with the entrepreneur depending on how he negotiates and designs each item of expenditure and according to his negotiation with each supplier. The important thing is to be clear about what suits you at each stage.

It is true that costs can be both fixed and variable, but it is also true that the entrepreneur has some room for manoeuvre in negotiating and designing the cost structure of his company. In many cases, different terms can be negotiated with suppliers to convert fixed costs into variable costs, or vice versa. For example, in the case of renting premises, a variable rent could be negotiated based on sales or the number of customers visiting the establishment. In this way, the cost would be directly linked to the performance of the business and would not be a fixed expense to be paid regardless of results. Similarly, the could negotiate with suppliers of materials or supplies so that costs are variable depending on the quantity or frequency of orders, rather than a fixed cost that is paid regularly regardless of the level of activity of the company. In short, While it is true that some costs are more difficult to convert into variable or fixed costs, the entrepreneur has some power to negotiate and design the cost structure that best suits his business model and long-term objectives.

Example of variable costs becoming fixed costs

An example of variable costs that become fixed costs is the rent of premises. In the beginning, a company may start operating from home or in a coworking space, which means that the cost of rent is variable and depends on the use of the space. However, as the company grows and needs its own space to operate, it may decide to rent premises on a long-term basis. In this case, the rental cost becomes fixed, as a certain amount must be paid each month, regardless of the use of the space. This change may involve a higher risk for the company, but it may also be a necessary investment for growth and expansion.

Case study to clarify concepts

Analyse these two situations to get a good understanding of the concepts. The two companies start from the same amount of costs, at the central point they earn the same, PrudenciosA has negotiated with suppliers more variable costs than fixed, and RiesgosA the other way around, preferring to negotiate more fixed than variable costs. If there is success, i.e. if sales go up by 50% or x1.5, RiskyA multiplies its result by 5.5, much more than PrudenciosA's x3. Which model do you prefer? Now look, if Murphy manages to affect us, and sales are halved, Risky loses much more. Do you still prefer the same model?

IN THIS EXAMPLE, IT IS CLEAR THAT RISK AND RETURN ALWAYS GO HAND IN HAND: 

SUCCESS

RisksA in case of success earns much more, 5 its benefits, compared to x3 for PrudenciosA. RisksA, is driven by the high expected profitability by taking riskier decisions, with more fixed cost strategies. that can be obtained in case of success, but with much higher risk, and can lose much more than prudentA when sales are lower....

TEMPTATION TO AVOID:

The more fixed costs, the more I earn when things go well, but the more I lose when things go badly. Beware that operational/financial leverage is only useful for large companies with very stable revenues that are assured of no change. Understand how a physical lever works. The business angels (+), want companies scalable (+), Therefore they will like models with FIXED costs that are not going to grow when sales are doubled. But you are not interested in what the business angel wants... at the beginning, be careful!

CONCLUSION

Be more prudent at the beginning to assume less risk. At the beginning it is better to have everything variable and gradually convert to fixed when I reach targets that allow me to have less uncertainty and more stable sales.

Why is it important to design an appropriate cost structure in a new company?

Designing an appropriate cost structure in a new business is important because it allows to effectively control and manage expenses and to ensure the long-term profitability and sustainability of the business. A proper cost structure helps to identify and prioritise the most important costs, establish a realistic and efficient budget, and make informed decisions on resource allocation. It can also help to optimise processes and increase the operational efficiency of the company, which can result in cost reductions. In short, a proper cost structure is essential for the success and survival of a new business.

What does it mean to convert a variable cost into a fixed cost?

Converting a variable cost into a fixed cost involves changing the nature of a cost that was previously directly associated with the volume of a company's production or sales, to a cost that does not vary with changes in the level of production or sales. In other words, it is a commitment to the supplier that the cost will remain constant, regardless of changes in the volume of business activity. This can have advantages, such as greater cost stability and a greater ability to forecast the company's financial results. However, it can also have disadvantages, such as increased financial risk in case the company experiences a decline in sales or production.

How do you negotiate with a supplier to move from variable to fixed?

To negotiate the change from a variable cost to a fixed cost with a supplier, the following steps can be taken:

1. Analyse the current relationship with the supplier: it is important to know the current relationship with the supplier and to assess whether it is a long-term relationship and whether the supplier is reliable.
2. Evaluate purchase history: the volume of purchases that have been made with the supplier in recent months and years should be assessed, as this can be an argument for negotiating the change from variable to fixed cost.
3. Set purchasing goals: it is important to set purchasing targets for the coming period and communicate them to the supplier. The supplier may be interested in making a fixed cost offer if he knows that he will receive a significant volume of purchases.
4. Negotiate payment terms: negotiate payment terms and ensure that they are fair and mutually beneficial. A supplier may be more willing to offer a fixed cost if they receive regular and timely payments.
5. Analyse the competition: competitors should be investigated to see if they offer better deals and use this as an argument to negotiate a change from variable to fixed cost.
6. Sign a contract: a contract should be signed with the supplier setting out the terms of the new fixed cost structure. The contract should be clear and detailed to avoid misunderstandings in the future.

It is important to remember that not all providers will be willing to offer a fixed cost and that it is necessary to carefully assess the risks and benefits of each option before making a decision.