The Cost Structure building block of the Business Model Canvas details the monetary cost of operating as a business. Cost structure represents all the costs a business will incur under a specific business model, especially those costs to maintain the key resources that make up the core business model.
Understanding cost structure in the Business Model Canvas
Do costs become variable or remain fixed by considering other structures?
Cost structure types
While minimizing cost is fundamental to good business, organizations nonetheless employ different cost structure strategies.
Some are on a dogged mission to reduce costs as much as possible, while others pride themselves on their luxury or bespoke product ranges. In truth, most organizations are somewhere in between.
Various strategies occupy opposite ends of a cost structure spectrum, with a cost-driven structure at one end and a value-driven structure at the other.
With all that said, let’s take a look at both types in more detail:
Value-driven structure
A strategy where there is a complete focus on customer value at the expense of cost. Value is created by customizing the product or service to individual preferences.
Hyatt Hotel repeat customers are on a first-name basis with hotel staff and are provided with a personalized room before they arrive.
Cost-driven structure
Which focuses on minimizing the cost of a product or service wherever possible.
Businesses focus on creating a lean cost structure through cheap pricing, automation, and the outsourcing of costly activities.
Walmart uses immense economies of scale to reduce costs to a point where other retailers cannot compete.
Most budget airlines reduce costs by increasing seat capacity, not offering meals, and limiting luggage size.
Cost structure attributes
A typical cost structure, regardless of strategy or type, has one or more of the following attributes:
Economies of scale
Where a company with a high output quota benefits from a lower cost per unit amount.
This occurs because large volume orders spread fixed costs more evenly than smaller orders.
Economies of scale are common in large organizations that make bulk purchases from a supplier.
Economies of scope
Here, costs are reduced when an organization expands its operational scope or invests in multiple markets.
To derive maximum benefit from economies of scope, each product should require similar marketing messages or utilize the same distribution channel.
Fixed costs
Or business expenses that remain constant irrespective of volume.
Fixed costs can be time-bound, such as a fortnightly employee salary or monthly rent for an office space.
Manufacturing companies are also subject to fixed costs such as equipment and facility rental.
Fixed costs do not remain fixed indefinitely and will change over time while remaining relatively stable.
Variable costs
These are costs that are heavily dependent on volume output and are influenced by supply and demand.
In a production scenario, variable costs may be associated with sourcing raw materials, utility bills, and employee labor.
Cost structure examples
In the final section, let’s take a look at a few cost structure examples from some notable companies.
Netflix
With over $29.7 billion in revenues, most of them came from streaming services, at $29.51 billion in 2021. While DVD revenues represented less than 1% of the total revenues at, $182 million. The streaming revenues grew at 19.2% in 2021, primarily driven by an increased Average monthly revenue per paying membership, which went from $10.91 in 2020 to $11.67 in 2021. In 2021 Netflix had over 221 million members, compared to the 203 million members in 2020.
The cost structure of Netflix was significant enough in the company’s early days to impact cash flow and growth. Some of these costs include:
The acquisition, production, delivery, and licensing of streaming content. These are likely to be the largest costs for the company today.
Platform maintenance.
Software development.
Research and patents.
Amazon Web Services (AWS) for database, analytics, recommendation engines, and video transcoding, to name a few functions.
Data centers to provide streaming content.
Marketing, human resources, and related infrastructure.
Netflix has also benefitted from economies of scope and key activities that match its value proposition.
Nike
The cost structure of Nike is such that the company pockets a relatively small amount of profit from each item it sells. Costs associated with the sale of a pair of sneakers, for example, include:
Free on Board (FOB) costs, which cover the cost of shipping from the factory.
Selling, general, and administrative expenses.
Customs duties and taxes.
In addition to these costs, Nike spends billions on advertising, marketing, sponsorships, brand presentation, and other promotional costs. In 2021, this amounted to $3.11 billion.
Tesla
Tesla’s cost structure is characterized by fixed manufacturing costs. For each vehicle that rolls off the production line, these include equipment (20%), body (12%), chassis (7%), drive system (15%), battery (35%), and other (11%).
In addition, Tesla has the following costs:
Research and development – consisting of personnel costs related to engineering, research, prototyping, contract and professional services, and costs from amortized equipment.
Selling, general and administrative expenses – personal and facilities related costs such as stores, sales, finances, human resources, information technology, and any fees related to legal or contract services and litigation settlements.
Restructuring and others – including employee termination costs, disposal of tangible assets, facility sub-leasing losses, and impairment losses.
Interest and taxes.
Airbnb
In Q3 2022, Airbnb recorded its most profitable quarter ever. With revenues of $2.89 billion in Q3 2022, Airbnb posted a record of $1.21 in net income. The first nine months of 2022 posted revenues of $6.5 billion and a net income of $1.64 billion. Thus Airbnb will be profitable in 2022.
Airbnb has a relatively simple cost structure when compared to some of its competitors in the hotel industry.
This is because the company does not own the accommodation listed on its website and as a result, avoids the many costs associated with hospitality staff and hotel upkeep.
The company’s cost structure consists of the following:
Cost of revenue – which includes online payment processing fees that are paid to Visa and Mastercard. Cost of revenue also encompasses insurance. In the rare event that a guest, host, or cleaner is injured or has their personal property damaged or stolen, Airbnb is responsible for paying out insurance claims.
Sales and marketing – such as customer acquisition, customer retention, discounts, promotions, referral fees, and refunds.
Research and development – there are also costs associated with ensuring the Airbnb platform is functional, on-trend, intuitive, and streamlined. Other research and development costs include engineering and product development.
General and administration – this includes costs related to administration and employees such as HR and finance, legal fees, executives, general managers, and professional services such as freelance photography.
Key takeaways
The Cost Structure building block of the Business Model Canvas details the monetary cost of operating as a business. This block is important to get right since many businesses fail due to misunderstanding or underestimating their costs.
Cost-structures may be value-driven or cost-driven. As the name suggests, value-driven structures focus on delivering customer value at the expense of minimizing cost. In a cost-driven structure, the opposite is true.
Regardless of type, most cost-structure have one or more of the following attributes: economies of scale, economies of scope, fixed costs, and variable costs.
This framework has been thought for any type of business model, be it digital or not. It’s a framework to start mind mapping the key components of your business or how it might look as it grows. Here, as usual, what matters is not the framework itself (let’s prevent to fall trap of the Maslow’s Hammer), what matters is to have a framework that enables you to hold the key components of your business in your mind, and execute fast to prevent running the business on too many untested assumptions, especially about what customers really want. Any framework that helps us test fast, it’s welcomed in our business strategy.
An effective business model has to focus on two dimensions: the people dimension and the financial dimension. The people dimension will allow you to build a product or service that is 10X better than existing ones and a solid brand. The financial dimension will help you develop proper distribution channels by identifying the people that are willing to pay for your product or service and make it financially sustainable in the long run.
This framework is well suited for all these cases where technology plays a key role in enhancing the value proposition for the users and customers. In short, when the company you’re building, analyzing, or looking at is a tech or platform business model, the template below is perfect for the job.
This framework is well suited to analyze and understand blockchain-based business models. Here, the underlying blockchain protocol, and the token economics behind it play a key role in aligning incentives and also in creating disincentives for the community of developers, individual contributors, entrepreneurs, and investors that enable the whole business model. The blockchain-based model is similar to a platform-based business model, but with an important twist, decentralization should be the key element enabling both decision-making and how incentives are distributed across the network.
A Blockchain Business Model according to the FourWeekMBA framework is made of four main components: Value Model (Core Philosophy, Core Values and Value Propositions for the key stakeholders), Blockchain Model (Protocol Rules, Network Shape and Applications Layer/Ecosystem), Distribution Model (the key channels amplifying the protocol and its communities), and the Economic Model (the dynamics/incentives through which protocol players make money). Those elements coming together can serve as the basis to build and analyze a solid Blockchain Business Model.
Venture capitalist, Dave McClure, coined the acronym AARRR which is a simplified model that enables us to understand what metrics and channels to look at, at each stage for the users’ path toward becoming customers and referrers of a brand.
A north star metric (NSM) is any metric a company focuses on to achieve growth. A north star metric is usually a key component of an effective growth hackingstrategy, as it simplifies the whole strategy, making it simpler to execute at high speed. Usually, when picking up a North Start Metric, it’s critical to avoid vanity metrics (those who do not really impact the business) and instead find a metric that really matters for the businessgrowth.
The profit margin is a profitability financial ratio, given by the net income divided by the net sales, and multiplied by a hundred. That is expressed as a percentage. That is a key profitability measure as combined with other financial metrics, it helps assess the overall viability of a business model.
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).
Business analysis is a research discipline that helps drive change within an organization by identifying the key elements and processes that drive value. Business analysis can also be used in Identifying new business opportunities or how to take advantage of existing business opportunities to grow your business in the marketplace.
The cash flow statement is the third main financial statement, together with the income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing, and financing. The cash flow statement can be prepared with two separate methods: direct and indirect.
A comparable company analysis is a process that enables the identification of similar organizations to be used as a comparison to understand the business and financial performance of the target company. To find comparables you can look at two key profiles: the business and financial profile. From the comparable company analysis, it is possible to understand the competitive landscape of the target organization.
The cost structure is one of the building blocks of a business model. It represents how companies spend most of their resources to keep generating demand for their products and services. The cost structure together with revenue streams, help assess the operational scalability of an organization.
Economic or market moats represent long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory for companies for tax purposes. They are also used by managers to assess the performance of the business.
A marketplace is a platform where buyers and sellers interact and transact. The platform acts as a marketplace that will generate revenues in fees from one or all the parties involved in the transaction. Usually, marketplaces can be classified in several ways, like those selling services vs. products or those connecting buyers and sellers at B2B, B2C, or C2C level. And those marketplaces connecting two core players, or more.
A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.
A platform business model generates value by enabling interactions between people, groups, and users by leveraging network effects. Platform business models usually comprise two sides: supply and demand. Kicking off the interactions between those two sides is one of the crucial elements for a platform business model success.
The virtuous cycle is a positive loop or a set of positive loops that trigger a non-linear growth. Indeed, in the context of digital platforms, virtuous cycles – also defined as flywheel models – help companies capture more market shares by accelerating growth. The classic example is Amazon’s lower prices driving more consumers, driving more sellers, thus improving variety and convenience, thus accelerating growth.
The Amazon Flywheel or Amazon Virtuous Cycle is a strategy that leverages on customer experience to drive traffic to the platform and third-party sellers. That improves the selections of goods, and Amazon further improves its cost structure so it can decrease prices which spins the flywheel.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
