low cost business model definition

Low-cost leadership strategy: Explained with examples

A low-cost leadership strategy is a business strategy where a company aims to become the most cost-efficient player in its industry, often by producing goods or providing services at a lower cost than its competitors. The overall goal is to increase market share or achieve higher profitability.

The low-cost leader in an industry often sets the price that other companies have to match or beat to stay competitive. This strategy requires strict control and constant monitoring of expenses to maintain low prices. It’s worth noting that implementing a low-cost strategy doesn’t necessarily mean the company should compromise the quality of its products or services. A balance between affordability and quality often leads to higher customer satisfaction.

What is strategic cost management?

This strategy can be achieved in several ways, including:

Economies of scale.

Economies of scale refer to the cost advantages businesses achieve due to their scale of operation, with cost per unit of output generally decreasing with increasing scale. This concept is a key component of a low-cost leadership strategy.

• Production Economies of Scale:  As a company increases its production volume, the cost of each unit produced decreases. This happens because the fixed costs, such as machinery, rent, and salaries, are spread over a more significant number of goods. For example, if a factory costs $1 million a year to operate, the cost is spread across more units if it produces 1 million units compared to 100,000 units.
• Purchasing Economies of Scale:  A larger business can purchase its raw materials in bulk, leading to significant supplier discounts. These discounts arise because processing a large order costs less than processing multiple small orders.
• Operational Economies of Scale:  Larger companies can afford to invest in high-end, more efficient technologies, machinery, and processes that might not be affordable for smaller companies on a per-unit basis. For instance, a large company can afford a fully automated production line that significantly reduces the labor cost per unit produced.
• Financial Economies of Scale:  Larger firms often have better access to funding at lower rates. Because of their size and often lower risk, banks and investors are usually more willing to lend money at lower interest rates.
• Managerial Economies of Scale:  Larger businesses can afford to hire specialists who increase efficiency in the different areas of the company, whereas smaller companies may need to rely on a few managers who aren’t experts in all areas.

Economies of scale provide a significant barrier to entry for new companies in the market because they may not be able to match the low costs and prices of the larger, more established companies. However, it’s essential to note that economies of scale can also turn into diseconomies of scale if the company grows too large and becomes challenging to manage effectively. This can lead to inefficiencies and higher per-unit costs.

Operational Efficiency 

Operational efficiency is a critical element of a low-cost leadership strategy. This involves optimizing various business operations to achieve the maximum output with the least input, thereby reducing costs. Businesses can focus on improving operations, such as manufacturing, supply chain, logistics, employee productivity, technology use, etc. Here’s how it works:

• Process Efficiency:  This refers to the methods and procedures used in producing goods or delivering services. Businesses can streamline these processes to eliminate waste, reduce delays, and improve productivity. For example, a company might implement lean manufacturing techniques to minimize waste and reduce costs.
• Technological Efficiency:  Technology can greatly enhance operational efficiency. Businesses can automate routine tasks to reduce labor costs and improve accuracy. For instance, implementing an automated inventory management system can reduce labor costs, minimize errors, and help prevent overstocking or understocking.
• Employee Productivity:  Businesses can enhance productivity by investing in employee training and development, improving workplace conditions, and implementing incentive systems to motivate workers. Higher productivity can lead to lower costs per unit.
• Supply Chain Optimization:  Efficient supply chain management can minimize costs for storage, transportation, and product loss. Businesses can negotiate better terms with suppliers, optimize delivery routes, and improve inventory turnover rates.
• Energy Efficiency:  Companies can significantly reduce energy costs by adopting energy-efficient machinery and practices.
• Quality Management:  By focusing on quality management and continuous improvement, businesses can reduce the costs associated with defects, returns, and customer dissatisfaction.

Operational efficiency is not a one-time effort but a continuous process of assessing, improving, and innovating business operations. While it’s a powerful strategy for cost leadership, businesses should ensure that their pursuit of efficiency does not compromise product quality or customer satisfaction. Indeed, achieving operational efficiency often leads to enhanced product quality and customer service, making it a win-win strategy.

Cost-effective Supply Chain Management 

Cost-effective supply chain management (SCM) is an important strategy for businesses aiming to achieve low-cost leadership. The supply chain involves all activities associated with producing and delivering a product or service, from sourcing raw materials to delivering the final product to customers. Businesses can reduce costs and gain a competitive advantage by optimizing these activities. Here’s how:

• Strategic Supplier Relationships:  Building long-term relationships with suppliers can lead to volume discounts, better credit terms, priority access to materials, and improved quality. Businesses might also collaborate with suppliers to improve product design or streamline processes.
• Inventory Management:  Effective inventory management can prevent overstocking or understocking, which can be costly. Businesses can use just-in-time inventory management, where materials arrive precisely when needed in production, reducing storage costs and wastage.
• Logistics and Distribution:  Optimizing delivery routes, consolidating shipments, and choosing the right transportation mode can minimize logistics costs. Businesses might also consider the strategic location of warehouses to reduce transportation time and cost.
• Technological Integration:  Using SCM software can help businesses automate and streamline supply chain processes, improve coordination with suppliers, and gain better visibility into their supply chain, all of which can lead to cost reductions.
• Risk Management:  Proactively managing supply chain risks can prevent costly disruptions. For instance, businesses might diversify their supplier base to avoid relying on a single supplier.
• Sustainability Efforts:  Sustainable SCM practices, like minimizing waste, reducing energy use, and sourcing from ethical suppliers, can not only reduce costs but also enhance a business’s reputation and appeal to environmentally-conscious customers.

Implementing a cost-effective supply chain management strategy requires a deep understanding of the supply chain, strong relationships with suppliers, and effective use of technology. While it can be a complex task, the potential cost savings make it a worthwhile effort for businesses pursuing a low-cost leadership strategy.

Product Design 

Product design plays a crucial role in a low-cost leadership strategy. Essentially, it involves designing less expensive products while still maintaining satisfactory quality and functionality. Here are a few ways how it works:

• Material Optimization:  Companies can use less expensive materials or minimize the amount of material used without compromising the quality and functionality of the product. For instance, reducing the weight of a product can lower both material costs and shipping costs.
• Design for Manufacturing (DFM):  DFM is the practice of designing products to make them easier and cheaper to manufacture. It might involve simplifying the design, reducing the number of parts, or designing parts to be multi-functional. The aim is to minimize the complexity of manufacturing processes, which can lead to cost savings in terms of reduced labor and machine time.
• Standardization:  By standardizing parts across different products, companies can produce these parts in large volumes, leading to economies of scale. It also reduces the need for storing and managing a wide variety of parts.
• Modular Design:  This involves designing a product as a collection of interchangeable components or modules. This allows for efficient mass production of modules and offers flexibility in assembling different product versions.
• Design for Reliability and Durability:  By designing products to be reliable and durable, companies can reduce costs associated with warranties, returns, and customer service.
• Sustainability Considerations:  Incorporating sustainable design principles can lead to cost savings in the long run. For example, using recyclable materials can reduce waste disposal costs and provide a source of inexpensive raw materials.

However, it’s important to remember that while product design can be a powerful tool for cost reduction, it must be balanced with other considerations, like product functionality, aesthetics, and consumer preferences. A product that is cheap to produce but doesn’t meet the needs and expectations of consumers will not be successful in the market.

Low-Cost Marketing

Low-cost marketing, sometimes known as cost-effective marketing or “guerrilla marketing,” can be a key aspect of a low-cost leadership strategy. The goal here is to achieve a high marketing impact at a low cost. This approach is particularly useful for small and medium-sized businesses that may not have large marketing budgets. Here’s how it works:

• Digital Marketing:  Utilizing digital channels like social media, email, search engine optimization (SEO), and content marketing can be very cost-effective. These methods often require more time than money, making them ideal for companies with limited budgets. For instance, creating high-quality content and sharing it on social media can attract organic traffic without the costs associated with traditional advertising.
• Referral Programs:  Word-of-mouth marketing can be a powerful and inexpensive way to acquire new customers. Companies can incentivize existing customers to refer their friends and family by offering discounts or free products.
• Partnership Marketing:  By partnering with other businesses with a similar target audience, companies can share marketing costs and broaden their reach. For example, a health food store might partner with a local gym to offer joint promotions.
• Community Engagement:  Engaging with the local community can be an effective, low-cost marketing strategy. This could involve sponsoring local events, giving talks, or participating in community projects.
• Customer Retention Strategies:  Retaining existing customers is usually more cost-effective than acquiring new ones. Strategies to enhance customer loyalty, such as loyalty programs, excellent customer service, and regular engagement, can lead to repeat business and referrals.
• Public Relations (PR):  Positive media coverage can be cost-effective to increase brand visibility. This could involve sending press releases, hosting events, or sharing interesting stories about your business with the media.
• Search Engine Optimization (SEO):  Investing in SEO can help your business website rank higher in search engine results, leading to more organic traffic and potential customers. This low-cost strategy involves optimizing your website content with relevant keywords and ensuring your site has a good user experience.

While low-cost marketing strategies can be effective, monitoring their performance and adjusting your approach as necessary is important. Also, low cost doesn’t mean no cost — these strategies still require time, effort, and sometimes a small budget to execute effectively.

Outsourcing 

Outsourcing involves hiring external firms or freelancers to perform certain business functions previously done in-house. It can be a powerful strategy for achieving low-cost leadership by transferring portions of work to outside suppliers rather than completing it internally. Here’s how it can contribute to a low-cost leadership strategy:

• Cost Savings:  Outsourcing can lead to significant cost savings, as businesses can often find external providers who can perform the work at a lower cost due to economies of scale, lower labor costs, or technical expertise.
• Focus on Core Business:  By outsourcing non-core activities, businesses can concentrate on their core competencies, like product development, customer service, or strategic planning, leading to better performance and efficiency.
• Access to Expertise:  Outsourcing can provide access to expert skills and advanced technologies that a business might not possess internally. This can improve the quality of work and productivity, often at a lower cost.
• Flexibility:  Outsourcing can provide flexibility, allowing businesses to scale operations up or down as needed without the commitment of hiring or laying off employees.
• Reduced Infrastructure Investment:  By outsourcing, companies can save on capital expenditure and maintenance costs associated with infrastructure, equipment, or technology necessary for certain tasks.

Commonly outsourced functions include IT services, customer service, marketing, accounting, human resources, and manufacturing. However, businesses must consider potential downsides, such as the risk of losing control over the outsourced function, potential quality issues, and the risk of sensitive information getting into the wrong hands. Therefore, careful selection of outsourcing partners and effective contract management is crucial.

It’s also important to note that successful outsourcing is not just about cost-saving but also about adding value to the business. Therefore, outsourcing should align with the overall business strategy and goals.

What is a Cost leadership strategy | Explained with Examples

Low-cost leadership strategy examples

Low-cost leadership strategies can be seen in several well-known businesses. Here are a few examples:

• Walmart:  Walmart is perhaps one of the best-known examples of a company using a low-cost leadership strategy. The company leverages its enormous scale to negotiate low prices from suppliers, and it invests heavily inefficient supply chain management. Its effective inventory management, technology use, and high-volume purchasing allow it to offer lower prices than many competitors.
• Amazon:  Amazon has also achieved low-cost leadership in online retail through its efficient supply chain management, advanced warehousing technology, and sheer scale. It uses data-driven strategies to manage inventory, and its Prime membership model encourages customer loyalty while providing a consistent revenue stream.
• Southwest Airlines:  In the airline industry, Southwest Airlines has used a low-cost strategy to differentiate itself. It achieves cost savings through operational efficiency, such as using a single aircraft model for all its flights to simplify maintenance and training, turning planes around quickly at the gate, and not assigning seats.
• IKEA:  IKEA has implemented a low-cost leadership strategy in the furniture industry by offering well-designed products at lower prices than many competitors. The company achieves this through efficient manufacturing, flat-pack shipping (which reduces transportation costs), and a business model that involves customers in product assembly.
• McDonald’s:  McDonald’s has used a low-cost leadership strategy to become one of the world’s leading fast-food chains. They achieve this by standardizing their products, using efficient cooking methods, and leveraging economies of scale.

Each company uses different techniques to achieve low-cost leadership, but all focus on offering their customers value for money. It’s also worth noting that low-cost leadership does not necessarily mean the cheapest price – it often means offering the best price for a particular quality or service.

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Low-Cost Producer: Definition, Strategies, Examples

Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.

What Is a Low-Cost Producer?

A low-cost producer is a company that provides goods or services at a low cost. In general, low-cost producers utilize economies of scale to execute their low price-strategy. Consumers who are sensitive to price changes will more likely shop at stores that offer the lowest prices—especially if the good or service is relatively homogeneous.

Low-cost producers have another option: To price the goods or services at the same level as their competitors and maintain a wider margin.

How Low-Cost Producers Work

A low-cost producer is capable of making a substitute good or providing a substitute service for a lower cost than other companies. They can price their goods on par with or just below the market, undercutting their competition. By doing so, companies can increase their market share and raise profits.

These goods and services are usually consumer staples which are in high demand. They tend to have readily available substitutes provided by many competitors in the marketplace. Consumer staples produced by low-cost producers generally include household items, cleaning products, food, beverages—any items that consumers cannot cut out. Specialty goods such as jewelry, high-end cars, and certain types of clothing generally do not have low-cost producers.

Unlike larger their larger competitors, many low-cost producers tend to concentrate on one or a few different consumer segments, which can help them keep their costs down, generate market share, and keep profits high.

Take supermarket chain Aldi, for example. Its footprint is much smaller than the average supermarket, yet it's still able to compete with its big-name rivals on a large scale. It offers a much smaller selection of goods, most of which are produced under its generic brand name, and the company is able to slash prices well below its competition. Walk through its aisles, and you'll notice they're stocked with items people tend to buy on a regular basis.

How to Become a Low-Cost Producer

The requirements to become a low-cost producer are great since there is quite a high barrier to entry in the market. Being this competitive in the market means raising capital or having enough in reserves to achieve economies of scale large enough to provide a distinct price advantage over competitors. This requirement is one reason why many companies are not able to be low-cost producers.

Becoming a low-cost producer has a high barrier to entry because it requires a great amount of capital.

Once this is achieved, companies will need to invest in technology that will keep production costs down, while boosting output. An important caveat is that firms need to ensure they keep up with demand and don't sacrifice their brand name.

Key Takeaways

• A low-cost producer is a company that uses economies of scale to provide goods or services at a low cost. 
• These goods and services are usually consumer staples which are in high demand such as household items, food, and beverages.
• Becoming a low-cost producer requires a large amount of capital and other technological advancements to boost production and cut down on costs.
• Walmart is one of the world's most well-known low-cost producers.

Example of Low-Cost Producer

Walmart is likely the best example of a low-cost producer with massive economies of scale. The company operates about 11,443 retail locations under different banners in 24 countries. Walmart has several strategies in place making it impossible for its competition to keep up. It's able to bring down the cost of goods it sells by procuring and buying on its own. And because of its massive footprint, Walmart can exert a lot of control over its suppliers.

The company is also able to run distribution through a fairly inexpensive network and has invested greatly in its technology, keeping up to date with its customer base. Doing so gives the company an edge, allowing it to better cater to the consumers who shop in store and online.

Walmart. " Location Facts ." Accessed April 1, 2021.

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Low Cost Business Strategy: A Guide you need

In today’s competitive market, businesses strive to find effective ways to thrive and gain a competitive edge. One powerful strategy that has emerged is the concept of a low-cost business strategy. This approach revolves around minimizing expenses and maximizing efficiency, allowing companies to operate leaner and achieve sustainable profitability.

In this blog post, we will explore the concept of a low cost business strategy, its significance in today’s market, and the numerous benefits it offers to organizations.

What is a Low-Cost Business Strategy?

A low-cost business strategy refers to a deliberate and systematic approach taken by companies to minimize costs across various aspects of their operations. It involves identifying areas of potential cost reduction, streamlining processes, negotiating favorable terms with suppliers, and embracing cost-saving technologies. The ultimate goal is to maintain a competitive advantage by offering products or services at lower prices than competitors while still delivering value to customers.

Importance of Low Cost Business Strategy:

In the current business landscape, the significance of a low-cost business strategy cannot be overstated. Here are a few reasons why it holds such importance:

• Competitive Pricing: By implementing a low-cost strategy, businesses can offer products or services at more attractive and competitive prices. This not only helps in acquiring new customers but also increases customer loyalty and retention, especially in price-sensitive markets.
• Profitability and Financial Stability: Keeping costs in check directly impacts a company’s profitability. By reducing expenses, businesses can improve their profit margins, allowing for reinvestment, expansion, or weathering economic downturns. Additionally, a low-cost strategy helps companies build financial stability and resilience in the face of market uncertainties.
• Market Penetration: Lower prices resulting from a low-cost strategy can facilitate market penetration and market share growth. It enables companies to reach a wider customer base, including price-conscious consumers who are more likely to choose affordable options over higher-priced alternatives.
• Competitive Advantage: Implementing a low-cost strategy can create a sustainable competitive advantage by establishing a reputation for affordability and value among customers. This advantage becomes even more critical in highly competitive industries where price is a primary decision-making factor for customers.
• Innovation and Agility: By focusing on cost optimization, companies are encouraged to think innovatively and find creative solutions to streamline processes . This mindset promotes operational efficiency, agility, and continuous improvement, driving long-term success.
• Adaptability to Changing Market Dynamics: A low-cost business strategy positions companies to adapt swiftly to changing market dynamics. They can adjust prices more flexibly, respond to competitor moves, and navigate economic fluctuations while still delivering value to customers.

In conclusion, a low-cost business strategy is a powerful approach that allows organizations to optimize costs, increase profitability, and gain a competitive advantage in today’s highly competitive market. By carefully assessing and managing expenses while still providing value to customers, companies can position themselves for long-term success and sustainability.

Factors Of Low Cost Business Strategy:

Implementing a successful low cost business strategy requires careful consideration of various factors and approaches. 

• Cost Analysis:
• Conducting a comprehensive cost analysis to identify areas of potential cost reduction.
• Analyzing direct and indirect costs, including materials, labor, overhead, and operational expenses.
• Identifying cost drivers specific to the industry and evaluating their impact on the overall cost structure.
• Assessing the cost-effectiveness of various processes, activities, and resources.
• Streamlining Operations and Processes:
• Eliminating unnecessary steps and activities that do not add value.
• Adopting lean manufacturing principles to optimize production processes.
• Reducing waste, minimizing defects, and improving overall operational efficiency.
• Streamlining supply chain management to minimize costs and improve responsiveness.
• Negotiating with Suppliers and Vendors:
• Seeking competitive bids and proposals from multiple suppliers.
• Negotiating favorable terms, prices, and discounts based on volume or long-term commitments.
• Building strong relationships with key suppliers to gain preferential treatment and access to better deals.
• Exploring opportunities for strategic partnerships or collaborations to share costs and resources.
• Minimizing Overhead Expenses:
• Evaluating and reducing non-essential overhead expenses.
• Considering shared office spaces or co-working arrangements to lower rent and maintenance costs.
• Embracing remote work options to reduce office-related expenses and overheads.
• Scrutinizing subscriptions, travel, and other discretionary expenses to eliminate or minimize them.
• Embracing Technology for Cost Savings:
• Adopting cloud-based software and services to reduce infrastructure and maintenance costs.
• Leveraging automation and digitization to streamline processes and reduce labor costs.
• Implementing cost-effective IT solutions that optimize resource utilization.
• Utilizing digital marketing channels for targeted and cost-efficient promotional activities and for better business marketing management .
• Continuous Improvement and Innovation:
• Cultivating a culture of continuous improvement to identify and address cost inefficiencies.
• Encouraging employee involvement and suggestions for cost-saving measures.
• Investing in research and development to explore innovative ways of reducing costs.
• Regularly reviewing and optimizing processes to adapt to changing market conditions.
• Training and Skill Development:
• Providing relevant training and skill development programs to employees.
• Equipping them with the necessary knowledge and skills to identify and implement cost-saving initiatives.
• Encouraging employees to proactively contribute ideas for cost reduction and process improvement.
• Performance Measurement and KPIs:
• Establishing key performance indicators (KPIs) to track and measure cost reduction efforts.
• Monitoring and analyzing financial statements, budget reports, and cost variance analysis.
• Conducting regular cost audits to identify potential areas for improvement.
• Using performance data to drive decision-making and allocate resources effectively.

By considering these factors and incorporating them into their strategic planning, organizations can successfully implement and maintain a low-cost strategy. It requires a holistic approach that encompasses cost analysis, operational efficiency, supplier management, overhead reduction, technology adoption, innovation, employee engagement , and effective performance measurement.

Examples of Low Cost Business Strategy:

Implementing a low cost business strategy can vary based on the specific industry, business model, and market conditions. Here are a few examples of how companies have successfully implemented low-cost strategies:

• Southwest Airlines adopted a low cost business strategy by focusing on operational efficiency and cost reduction measures.
• They streamlined their operations by utilizing a single aircraft model (Boeing 737), reducing maintenance and training costs.
• The company also implemented a quick turnaround strategy at airports, minimizing idle time and maximizing aircraft utilization.
• By reducing costs and offering competitive fares, Southwest Airlines gained a significant market share and sustained profitability.

• IKEA is known for its low cost business strategy in the furniture retail industry.
• They focus on minimizing costs throughout the value chain, from sourcing raw materials to distribution.
• IKEA designs products for self-assembly, reducing production and labor costs.
• They leverage economies of scale by bulk purchasing and implementing efficient supply chain management.
• Through their low-cost approach, IKEA offers affordable furniture to customers while maintaining profitability.

• Dollar General, a discount retailer, implements a low-cost strategy by targeting price-sensitive consumers.
• They optimize their store layouts to maximize space utilization and minimize operational costs.
• Dollar General strategically locates their stores in rural and suburban areas to reduce rent expenses.
• By focusing on private label brands and efficient inventory management , they offer affordable products with higher profit margins.

• Aldi, a global supermarket chain, follows a low-cost strategy by offering a limited assortment of high-quality private label products.
• They emphasize cost reduction through streamlined operations, efficient supply chain management, and store layouts.
• Aldi minimizes overhead costs by utilizing a deposit system for shopping carts and requiring customers to bring their own bags.
• Through their low-cost approach, Aldi provides customers with affordable groceries without compromising quality.

• Amazon incorporates a low-cost strategy in its e-commerce operations.
• They focus on efficient logistics and supply chain management to minimize costs and optimize delivery times.
• By leveraging technology and automation, Amazon reduces labor costs in their fulfillment centers.
• Through economies of scale, they negotiate favorable terms with suppliers and pass on cost savings to customers.

These examples illustrate different approaches to implementing low-cost strategies across various industries. By focusing on cost reduction, operational efficiency, supply chain management, and innovative business models, these companies have achieved sustainable profitability while delivering value to their customers.

Conclusion:

A low-cost business strategy is of paramount importance in today’s competitive market. By implementing cost-saving measures and optimizing operations, organizations can gain a competitive edge, improve profitability, and achieve long-term success. It enhances competitiveness, attracts price-conscious customers, and fosters customer loyalty. Moreover, a low-cost strategy creates a sustainable competitive advantage, differentiating businesses from competitors solely focused on premium pricing. It also contributes to financial stability, resilience, and business continuity. It is essential for readers to evaluate their own operations, identify cost-saving opportunities, and implement a low-cost mindset to unlock growth and success in their organizations. Embracing a low-cost strategy is not about compromising quality but finding innovative ways to optimize costs while meeting customer needs. By taking incremental steps and staying adaptable, businesses can position themselves for success and a prosperous future.

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What Is a Business Model?

• Andrea Ovans

A history, from Drucker to Christensen.

A look through HBR’s archives shows that business thinkers use the concept of a “business model” in many different ways, potentially skewing the definition. Many people believe Peter Drucker defined the term in a 1994 article as “assumptions about what a company gets paid for,” but that article never mentions the term business model. Instead, Drucker’s theory of the business was a set of assumptions about what a business will and won’t do, closer to Michael Porter’s definition of strategy. Businesses make assumptions about who their customers and competitors are, as well as about technology and their own strengths and weaknesses. Joan Magretta carries the idea of assumptions into her focus on business modeling, which encompasses the activities associated with both making and selling something. Alex Osterwalder also builds on Drucker’s concept of assumptions in his “business model canvas,” a way of organizing assumptions so that you can compare business models. Introducing a better business model into an existing market is the definition of a disruptive innovation, as written about by Clay Christensen. Rita McGrath offers that your business model is failing when innovations yield smaller and smaller improvements. You can innovate a new model by altering the mix of products and services, postponing decisions, changing the people who make the decisions, or changing incentives in the value chain. Finally, Mark Johnson provides a list of 19 types of business models and the organizations that use them.

In The New, New Thing , Michael Lewis refers to the phrase business model as “a term of art.” And like art itself, it’s one of those things many people feel they can recognize when they see it (especially a particularly clever or terrible one) but can’t quite define.

• AO Andrea Ovans is a former senior editor at Harvard Business Review.

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Business Model Generation: Value proposition

Proven business models that have driven success for global leaders across industries. Rethink how your business can create, deliver, and capture value.

No Frills is a business model that aims to reach a broad, price-sensitive audience by offering minimal products and services at significantly lower prices. This strategy relies on consistently adjusting processes to minimize costs and consistently utilizing production capacities through standardization of offerings. By optimizing distribution through methods such as Self-Service, No Frills is able to maintain profitability in the mass market. The key to success in this model is to focus on trimming the value proposition in areas where the greatest cost reduction can be achieved.

Where did the No Frills business model pattern originate from?

Henry Ford is widely recognized as a pioneer of the No Frills business model, having introduced his famed Model T in 1908 at the remarkably low price of $850. Ford was able to achieve this price point through the implementation of large-scale manufacturing techniques and the use of assembly lines, which allowed for efficient production but limited customization options for customers. The Model T’s simple construction, featuring a 20 horsepower engine on a steel chassis, also contributed to its affordability. This strategy proved extremely successful, as the Model T became the best-selling car in the United States by 1918 and saw over 15 million units sold by the time production ceased in 1927.

Applying the No Frills business model

The No Frills business model is well-suited for markets with cost-conscious customers, as these consumers are highly sensitive to price and will only consider purchasing products and services at a sufficiently low cost. To effectively utilize the No Frills model in these markets, it is important to take advantage of economies of scale and standardize products, processes, and services in order to reduce costs. Emerging markets, with their focus on “frugal” products, are particularly fertile ground for No Frills offerings. The guiding principle of this model is the adage “less is more.”

The Cost Advantage

A business may leverage the cost advantage when it is able to produce a product or provide a service at a lower cost than its competitors. This advantage can be applied in two ways: by lowering prices below the competition to attract more customers and gain market share, or by maintaining prices equal to the competition while enjoying a lower cost structure and increased profitability.

To establish a cheap cost structure, businesses may utilize low-cost raw materials, sustainable processes and technologies, efficient distribution methods, low-cost sales strategies, outsourced services, and lean manufacturing techniques.

Low Cost Design

There are two main design models for low cost products:

• Low cost adaptation , which involves reducing non-essential functions of an existing product to minimize cost while minimizing reduction of client utility
• Smart low cost design , which involves designing a product that meets both the desired functions of the customer and a cost goal while maximizing client utility.

Both of these models require a clear understanding of the main function of the product in order to avoid compromising functions that provide high utility to the client. They also emphasize the importance of considering low cost design as a design issue rather than solely a production and operational efficiency issue.

Allow yourself to specify cost reduction as a design goal rather than a general company objective.

Ibis Budget Hotels

No mini-bars, limited opening hours for receptions, and smaller rooms to clean allow renting out rooms for a bargain price.

With no reception, fitness classes, cafés, or saunas, the gym chain manages to stay cheap and open 24/7.

Southwest Airlines

Pioneered the low-cost carrier model in the 1970s by offering cheap fares with minimal amenities such as seat reservations, meal service, and travel agency booking assistance. Rather than using major airports, they operate flights to smaller, peripheral airports with lower airport taxes. This model has drastically changed the airline industry, with an estimated every second flight in Europe being operated by a low-cost carrier.

In the 1940s, the company implemented drastic changes such as reducing the menu to under ten items, using paper plates, and introducing a cheaper burger preparation method. This resulted in a reduction of waiting staff and the introduction of Self-Service. The No Frills concept helped the restaurant recover and remains a part of its philosophy today.

Aldi and Lidl

The European supermarkets sell groceries at low prices by avoiding branded products and limiting product selection on shelves. This strategy results in high turnover, which allows for savings on inventory costs and negotiating leverage with suppliers. To further cut costs, these stores often have minimal decor and staff.

Trigger Questions

• Have customers become used to an over-engineered offering that could be redesigned to be much simpler?
• What basic and core customer needs can you focus on in a standardized solution with little variety?
• On what occasions is it imperative to differentiate ourselves?
• How can we devise unorthodox approaches to targeting cost-sensitive emerging markets that are impacted by over-engineered societal constraints?
• Where in the value chain can we eliminate waste and lower costs?
• How can we achieve economies of scale in purchasing, production, R&D, and distribution?
• Is it possible to fundamentally redesign our processes to achieve cost savings?

This business strategy is part of the Business Model Patterns printed card deck .

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• Business Model Navigator by Karolin Frankenberger and Oliver Gassmann
• No Frills by Wikipedia
• Low Cost Business Model by Daniel Pereira
• Strategies to fight low-cost rivals by Nirmalya Kumar

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Validation Patterns

Validate the problem.

Is your problem worth solving?

• Closed-Ended Surveys
• Cold Calling
• Comprehension Test
• Contextual Inquiry
• Crowdfunding
• Crowdsourcing
• Customer Service Logs
• Fake door testing
• Family Tree
• Find the Watering Hole
• Five People Who Are In
• Five Second Test
• Focus Group
• Industry Forums
• Move in With the Customer
• Read App Reviews
• Remote User Testing
• Sell the Future
• Write Down Your Concept

Validate the market

Don't build something that nobody wants

• Classified Posting
• Collect Pre-orders
• Conjoint Analysis
• Data Mining
• Feature Stub
• High Hurdle
• Offer a Sample
• One Night Stand
• Physical Before Digital
• Product-Market Fit Survey
• Run Test Ads
• Sales Pitch
• Single-Feature Product
• Spoof Landing Pages
• Trends and Keyword Analysis
• Wizard of Oz

Validate the product

Does your product solve the problem?

• A/B Testing
• Beta Launch
• Clickable Prototype
• First Click Testing
• Guerilla User Testing
• Impersonator
• LEGO prototype
• Micro Surveys
• Minimum Marketable Product
• Multivariate Testing
• Net Promoter Score (NPS)
• Paper Prototype
• Pretend to Own
• Takeaway Test
• Try it Yourself
• Working Prototype

Validate willingness to pay

Are people willing to reach into their wallets?

Business Model Patterns

Customer segment.

Meeting the unique needs of each and every customer

• Customer Loyalty Program
• Ultimate Luxury

Pricing Model

Innovative pricing strategies for sustainable growth

• Access over Ownership
• Bait and Hook
• Cash Machine
• Dynamic Pricing
• Pay What You Want
• Reversed Bait and Hook

Revenue Streams

Explore different revenue streams to maximize potential

• Fractional Ownership
• Franchising
• Hidden Revenue
• Microfinance
• Pay Per Use
• Performance-Based Contracting
• Subscription
• Virtual Economy
• Rent Instead of Buy

Value Network

Sharing resources and risks for mutual benefit in the network

• Affiliation
• Brands Consortium
• Joint Venture
• Layer Player
• Multi-Sided Market
• No Middle Man
• Omnichannel
• Orchestrator
• Peer-to-Peer
• Platform as a Service
• Revenue Sharing
• Self-Service
• Shop in Shop
• Virtualization

Value Proposition

Value proposition strategies for long-term success

• Blended Value
• Cross Selling
• Experience Selling
• Guaranteed Availability
• Ingredient Branding
• Make More of It
• Mass Customization
• One-stop-Shop
• Product as Point of Sale
• Product Self-Service
• Sensor as a Service
• Solution Provider
• White Label

Value Proposition Development

Unlocking growth through value proposition design

• Digitization
• From Push to Pull
• Leverage Customer Data
• Open Business Model
• Open Source
• Reverse Engineering
• Trash-to-Cash
• User Designed

Workshop Patterns

Convert empathy to clarity by refining insights into problem definitions

• Dependency Mapping
• Future-Back Planning
• Future Press Release
• Objectives and Key Results

Uncover insights and drive problem-solving through deep analysis

• Assumptions Collection
• Business Model Mapping
• Circles of Influence
• Empathy Mapping
• Fishbone Diagram
• Force Field Analysis
• Force Field Network
• Hopes and Fears
• Impact Mapping
• Journey Mapping
• Market of Skills
• Opportunity Solution Tree Mapping
• Prototype Persona
• Service Blueprint
• Six Thinking Hats
• Skills Star Mapping
• Stakeholder Mapping
• Starbursting
• Touchpoint Mapping
• User Story Mapping
• Value Proposition Mapping
• Why-How Laddering
• Adjacency Matrix
• 20-Year Brand Roadmap
• Competitive Landscape
• Design Principles
• Golden Circle
• Golden Path
• Hypothesis Statement
• Job Stories
• Personality Sliders
• Problem Statement
• Product Box
• Storyboarding
• Top Audiences
• Top Brand Values
• Value Proposition Statement

Unleash creativity to collaboratively discover fresh solutions

• 3-12-3 Brainstorm
• Bad Idea Brainstorming
• Competitor Demos
• Crazy Eights
• Design Charrette
• Figure Storming
• Forced Analogy
• How Might We
• Mind Mapping
• Perfection Game
• Powers of Ten
• Reverse Brainstorming
• Round Robin
• The Anti-Problem
• Yes, And! Brainstorm
• Head / Heart / Hand
• PEST Analysis
• Rose / Thorn / Bud
• Start / Stop / Continue
• SWOT Analysis

Prioritize ideas or challenges to determine where to direct your attention and efforts

• Assumptions Mapping
• Blind Voting
• Decider Vote
• Fist to Five
• Five-Fingered Consensus
• Heatmap Voting
• Letter to Myself
• Note and Vote
• Priority Mapping
• Project Plan
• Prune the Product Tree
• RACI Matrix Mapping
• Red:Green Cards
• Roles and Responsibilities
• Roman Voting
• Stack Ranking
• Trade-off Sliders
• Who / What / When Matrix

Build a shared understanding to reach your goals together

• Fishbowl Discussion
• Lean Coffee
• Mad / Sad / Glad
• Plus / Delta
• Three Little Pigs

Core techniques used to plan and lead effective workshops

• Affinity Mapping
• Card Sorting
• Parking Lot
• Poster Session
• Return on Time Invested
• Safety Check
• Silent Storming
• Talking stick

Ice Breakers

Relieve initial group awkwardness and establish a safe space

• Personal Histories

Persuasive Patterns

Encourage action by eliciting positive or negative emotions about the behavior or situation.

• Anchoring Bias
• Authority Bias
• Cashless Effect
• Commitment & Consistency
• Curiosity Effect
• Endowment Effect
• Halo Effect
• Humor Effect
• Intentional Gaps
• Isolation Effect
• Need for Closure
• Optimism Bias
• Peak-End Rule
• Priming Effect
• Reciprocity
• Retaliation
• Scarcity Bias
• Serial Positioning Effect
• Status-Quo Bias
• Value Attribution

Restructure

Alter physical or social environments to subtly shift behavior patterns.

• Decoy Effect
• Default Effect
• Framing Effect
• Hedonic Adaptation
• Loss Aversion
• Risk Aversion

Broaden knowledge or insight regarding the behavior or situation to inform decisions.

• Analysis Paralysis
• Cognitive Dissonance
• Conceptual Metaphor
• Delay Discounting
• Inaction Inertia Effect

Demonstrate

Show practical examples or models of the desired behavior for clear guidance.

• Recognition over Recall
• Role Playing
• Storytelling

Connect the behavior to individual values and concerns, making it personally relevant.

• IKEA Effect
• Liking Bias
• Negativity Bias
• Noble Edge Effect
• Nostalgia Effect
• Positive Mimicry
• Self-Expression
• Social Proof

Highlight current actions and their reasons, bringing unconscious habits to awareness.

• Centre-Stage Effect
• Periodic Events
• Picture Superiority Effect

Streamline the process or action, making it more accessible and less daunting.

• Appropriate Challenges
• Autonomy Bias
• Choice Closure
• Commitment Devices
• Endowed Progress Effect
• Feedback Loops
• Fresh Start Effect
• Limited Choice
• Pattern Recognition
• Present Bias
• Zeigarnik Effect

Develop necessary skills and competencies to enable effective action.

• Competition
• Unlock Features

Increase the expectation of costs or consequences of action.

• Sunk Cost Bias

Use the promise of rewards to motivate and encourage desired actions or behaviors.

• Achievements
• Goal-Gradient Effect
• Prolonged Play
• Temptation Bundling

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Low cost strategy, page actions.

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Low- cost strategy (also Low-cost price) is a pricing strategy characterized by low prices of goods and services using various saving methods. The company skillfully reduces real costs, which contributes to more customers and thus increases its sales.For example, two companies produce the same product , sell at the same price , but a company with lower costs will earn more because it has a greater profit on sales [1] .

These companies don't pay attention to the quality but the number of goods and services sold. This is how the market of "cheap companies" is shaped. The strategy is hassle-free , because the only tool it uses is to minimize costs. It is important to have large capital, high technical capacity and invest in the latest technologies that save costs [2] .

By focusing on reducing costs, we become a low-cost provider. It has a strong competitive approach that displaces companies sensitive to price changes. The cost advantage over rivals is the basis for applying this strategy. Companies choosing the assortment suggest products that the buyer considers necessary. To implement the strategy and become a low cost provider, you need to achieve its maximum effectiveness . The strategy introduced should be difficult to kick or match with rivals [3] .

• 1 Examples of low cost strategy
• 2 Variants of implementing the low-cost strategy
• 3 Benefits of low cost strategy
• 4 Risks of low-cost strategy
• 5 Porter's theory
• 6 Footnotes
• 7 References

Examples of low cost strategy

Here are a few examples of companies that have successfully implemented a low-cost strategy:

• Walmart : Walmart has long been known for its low prices, achieved through economies of scale, efficient supply chain management , and a focus on process efficiency .
• Ryanair : The Irish budget airline has successfully implemented a low-cost strategy by offering no-frills flights, low prices, and charging for additional services such as baggage and seat selection.
• IKEA : The furniture retailer offers a wide range of affordable products, achieved through efficient supply chain management, economies of scale, and a focus on simplicity and function over form.
• Amazon : Amazon's low-cost strategy is based on efficiency and economies of scale, achieved through its advanced logistics and distribution network , and automation in warehouses.
• Southwest Airlines : the company has been known for its low prices, achieved through a focus on efficiency, a no-frills approach, and a simplified fleet of aircraft.
• Aldi : The German supermarket chain Aldi has a well-established low-cost strategy, this is achieved through its focus on own-brand products, efficient supply chain management, and minimal store design.
• Dollar General : The discount retailer offers a wide range of products at low prices, achieved through a focus on cost-effective sourcing and efficient store operations.

Variants of implementing the low-cost strategy

The company has two options to implement a low-cost strategy [4] :

• Using a lower price to attract sensitive price buyers and thus force price reductions among competitors, to increase total profits
• Maintaining the current price comparable to other low-priced rivals by using lower costs and thereby increase the profit margin on each unit sold and return on investment

In wider meaning of this term whe can find more ways a company can implement a low-cost strategy :

• Economies of scale : By producing a large volume of goods or services, a company can spread fixed costs over a larger number of units, resulting in a lower cost per unit .
• Process efficiency : A company can use efficient technology , automation, and streamlined processes to reduce the cost of production .
• Outsourcing : A company can outsource certain functions or production to countries where labor and materials are cheaper.
• Supply chain management : A company can negotiate better deals with suppliers and optimize its logistics to reduce the cost of raw materials and transportation.
• Lean management : A company can use Lean management principles to eliminate waste and improve efficiency in production, resulting in lower costs.
• No-frills : A company can offer a no-frills version of a product or service which is less expensive but less feature-rich or luxurious than its competitors.
• Volume discounts : A company can offer volume discounts to customers who buy large quantities of goods or services, reducing the cost of sales .

Benefits of low cost strategy

A low cost strategy can provide several benefits for a business, including:

• Increased competitiveness : By keeping costs low, a business can offer products or services at a lower price than its competitors, making it more attractive to price-sensitive customers.
• Increased market share : Lower prices can attract more customers, allowing the business to increase its market share.
• Improved profitability : By keeping costs low, a business can increase its margins and improve its overall profitability.
• Reduced risk : A low cost strategy can reduce the risk of financial loss if market conditions change or demand for the business's products or services decreases.
• Greater flexibility : A low- cost structure can also give a company more flexibility in its operations, allowing it to respond more quickly to changes in the market.
• Easier to scale : A low-cost business model is often easier to replicate and scale to other locations or markets.

Risks of low-cost strategy

Companies that strive for low-cost as cheap manufacturers or service providers are becoming a heavy burden for the company. Low-cost strategy is vulnerable to risks such as [5] :

• Constantly introduced technological changes are a big problem for earlier investments because they cease to be valid
• Risks associated with imitation by later companies that use the cheap learning method
• By minimizing costs, companies don't pay attention to individual needs and preferences of customers
• Companies due to unforeseen cost inflation , which negatively affects the company's tendency to offset product differentiation through cost leadership

Therefore, implementing a low-cost strategy can come with certain risks, such as:

• Quality issues : In an effort to reduce costs, a company may cut corners on quality, which can lead to customer dissatisfaction and a loss of reputation.
• Dependence on low-cost suppliers : A company that heavily relies on low-cost suppliers may become vulnerable to supplier disruptions or price increases.
• Price wars : If a company's low-cost strategy leads to lower prices in the industry , competitors may respond by also lowering prices, leading to a price war and reduced profits for all companies involved.
• Brand perception : A company that is known for low prices may struggle to attract premium customers or to increase prices in the future.
• Limited market : A low-cost strategy may only be successful in price-sensitive segments of the market and may not be sustainable in the long-term.
• Cost escalation : A company may find it difficult to maintain low costs in the long run due to factors such as wage inflation , increased competition, and supply chain disruptions .
• Reliance on cost cutting : A company that is heavily focused on cost cutting may not invest enough in research and development, marketing, or other areas that are important for long-term growth.

Porter's theory

It is worth mentioning Porter's theory. He distinguished two strategies to increase long-term competition on the market. The first model is characterized by minimizing costs at a level lower than that of the competition, thus increasing the profit margin. Costs are reduced most often when using economies of scale . Companies offer a standard product, without any additions. It is worth adding that there is only one place on the market for one company that applies this strategy, and then I become a cost leader. The rest of the competition most often loses market share or changes strategy. Another model concerns the reduction of costs for research and development as well as advertising and marketing . The second strategy Porter mentioned was to create unique products. The strategy is aimed at loyal brand customers, offering them a unique design and best quality products [6] .

• ↑ Diaconu L., (2009), p.81
• ↑ Diaconu L., (2009) p.82-84
• ↑ Diaconu L., (2009) p. 82-84
• ↑ Baldwin D., (2014)
• ↑ Tanwar R., (2013), p.17
• ↑ Porter M.E., 1998, p.11-14

• Baldwin D. (2014), Strategy: Low Cost or Differentiation
• Diaconu L. (2009), Strategic options of the low-cost companies ,Faculty of Economics and Business Administration in Romania, Romania
• Kankam-Kwarteng C.,Osman B., Donkor J. (2019) Innovative low-cost strategy and firm performance of restaurants: The moderation of competitive intensity , Emerald Publishing Limited
• Porter M.E. (1998), Competitive advantage : Creating and Sustaining Superior Performance The Free Press, New York,
• Tanwar R. (2013) Porter’s Generic Competitive Strategies , IOSR Journal of Business and Management

Author: Natalia Woźniczka

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What is a Business Model? Types, Examples, and Components

Defining a business model.

Peter Drucker defined the term business model as “assumptions about what a company gets paid for”. While that is a true statement, a business model is more than that. It outlines the products or services the business plans to sell, its identified target market, and any expected expenses. Business models are pivotal for both new and established businesses. They help operators understand their business structure and dive deep into the workings of their operations and market positioning.

Importance of a Business Model

A business model serves as a roadmap for the business, outlining clear strategies and objectives. A well-defined business model helps attract investors, guiding leaders in decision-making, and providing a clear understanding of how to create value for customers. It also assists in understanding and predicting the financial health of the business.

Types of Business Models

Examples of business models.

To get a better understanding of the types of business models available, let’s take a look at some of the most common business models used by businesses and startups. There are dozens of types of models but these are some of the types most people are familiar with.

Key Components of a Business Model

1. value proposition.

This aspect is not just about the product or service itself but also includes elements like customer service, brand reputation, and overall customer experience. For example, Apple’s value proposition is not just in its innovative products but also in its ecosystem and brand prestige.

2. Revenue Streams

3. market segmentation.

Market segmentation involves dividing a target market into manageable groups. Businesses can segment their market by demographics, geography, behavior, or other criteria. Understanding these segments allows companies to tailor their offerings and marketing strategies to meet the specific needs of each group. For example, a cosmetic company might segment its market into different age groups, offering different products to teenagers, adults, and seniors.

4. Cost Structure

5. business processes, 6. resources.

Resources are the assets a company needs to create and offer its value proposition, reach its market, and deliver on its business processes. These can be physical (like buildings and machinery), intellectual (like patents and trademarks), human (skills and expertise), or financial. Effective management of these resources is crucial for the success of a business model. For example, a technology startup might rely heavily on human resources in the form of software developers and engineers.

7. Customer Relationships

8. distribution channels, 9. key partnerships.

Many business models rely on partnerships with other companies to operate effectively. These partnerships can include suppliers, distributors, or even complementary businesses. Collaborations can help businesses expand their capabilities, reach new markets, and share risks. For example, a car manufacturer might partner with technology firms to develop new in-car entertainment systems.

Challenges and Considerations in Developing a Business Model

Globalization introduces complexities in expanding into international markets. A business attempting this would need to have a good understanding of different cultural norms, legal environments, and economic conditions. This requires businesses to adapt their models to various regional contexts while maintaining their core identity and values. Moreover, in an increasingly digital world, ensuring customer data privacy and security has become paramount. Companies must protect customer information, comply with data protection regulations, and maintain customer trust.

8 Key Elements Of A Business Model that You Should Understand

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Low Cost Strategy - Meaning, Factors & Example

What is low cost strategy.

Low cost strategy is a type of pricing strategy in which the firm offers the products at low price. This strategy helps to stimulate the demand & gain higher market share. The firm can gain cost advantages by increasing their efficiency, taking advantage of economies of scale, or by getting the raw material at low cost.

Factors which help Low Cost Strategy

For a firm to be cost leader and adopt low cost strategy, the following factors are important:

1. Access to capital to make significant investments.

2. Efficiency in Production system

3. Expertise to improve the manufacturing process

4. Acquire Raw materials at lower cost

5. Low labor costs

6. ability to outsource

The low cost strategy also comes up with the risk that other firms may also reduce their prices & a price war may start.

• Low-end Entry Level Brand
• Low Involvement Hierarchy

Low Cost Strategy Example

Low cost strategy is used by lot of domestic airlines which offer tickets at a very low price to acquire customers and first time fliers. This was made possible by adding frequent sectors in the routes and offering no-frills flying experience and more seating in one flight. This helped many airlines to cut cost and overall cut the ticket prices leading to more people flying in various sectors.

Hence, this concludes the definition of Low Cost Strategy along with its overview.

This article has been researched & authored by the Business Concepts Team . It has been reviewed & published by the MBA Skool Team. The content on MBA Skool has been created for educational & academic purpose only.

Browse the definition and meaning of more similar terms. The Management Dictionary covers over 1800 business concepts from 5 categories.

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The Benefits of a Low-Cost Business Model

By alex ryzhkov, related blogs.

• What Is a Maker Business Model and How Can You Use It?
• What Is the Best Way to Use Scenario Planning?
• How to Secure Funding for Your Business Plan
• Investing in Fund Windows: Tips, Tricks and Strategies for Maximum Returns
• Understanding the Different Types of Exit Strategies

Introduction

A low-cost business model is one in which the company's operations are designed to minimize overhead costs while still producing competitive, quality products or services. It is a strategy that allows the business to stay competitive in the market while keeping the costs of operation low. This approach can be quite beneficial for small businesses and startups that need to watch their budgets.

In this blog post, we will take a closer look at the benefits of a low-cost business model and how it can help businesses of all sizes. We will explore topics such as cost savings, improved efficiency, and increased customer satisfaction.

Key Takeaways

• Low-cost business models can help businesses stay competitive in the market while keeping the costs of operation low.
• Cost savings, improved efficiency, and increased customer satisfaction are all benefits of low-cost business models.
• A low-cost business model can help businesses of all sizes maximize their profits and efficiency.

Cost Savings

A low-cost business model can help companies increase their cost savings. This can be achieved by reducing expenses, reducing labor costs, and finding cost efficiencies.

Reduced Expenses

Reducing expenses can be done through sourcing cheaper supplies, finding better prices for services, negotiating better terms with vendors, or finding more cost-effective ways to accomplish tasks. For example, trading in an expensive software for a cheaper version, or cutting back on unnecessary travel can be great ways to reduce expenses.

Reduced Labor Costs

Reducing labor costs can be done in a few different ways. Companies can outsource tasks to countries with lower wages, or hire freelancers for short-term needs. Additionally, companies can reduce the number of full-time employees they have, and rely more heavily on part-time staff or contractors.

Cost Efficiencies

Cost efficiencies can be gained by streamlining processes, eliminating wasteful spending, and finding ways to reduce or even eliminate inefficiencies. For example, businesses can use technology like automation or artificial intelligence to increase productivity, and develop cost-saving protocols to save money. Additionally, businesses can review their existing processes and work to identify any redundancies that can be elimintated.

Reduced Risk

The low-cost business model offers numerous advantages by reducing risk in multiple areas. When considering financial outlays, companies can make an informed decision on when to invest in resources. With this model, the initial capital outlay required to get off the ground is often significantly lower.

Less Capital Outlay for Inventory, Equipment, etc.

Companies are able to make decisions on when to invest in the necessary equipment to run their business. With the lower start-up cost, businesses can take a measured approach addressing only the items critical for moving in the right direction. By purchasing only the necessities, organizations are able to spread out their costs, ultimately minimizing the initial financial outlay.

Lower Financial Risk

The low-cost business model reduces financial risk independently. Organizations are able to scale their costs as the business grows. With curated spending and higher-than-expected returns, businesses can ensure that their finances are not overextended.

Lower Risk of Overstocking or Obsolescence

With fewer upfront costs, organizations often have the ability to purchase only the inventory and equipment they need to start their business. This helps reduce the risk of overstocking and obsolescence, allowing businesses to stay abreast of the latest market trends. Much like the low financial outlay, companies are able to purchase inventory and equipment only when necessary.

Streamlined Processes

A low-cost business model leads to streamlined processes and a more efficient organization. Specifically, low-cost business models give companies an enhanced ability to compete, increased productivity, and reduces waste.

Enhanced Ability to Compete

A low-cost business model gives companies the ability to compete more effectively against larger rivals. Low-cost businesses can use a leaner structure and more efficient processes to avoid the high costs associated with larger businesses. This means that low-cost businesses can often undercut competitors on price, while still maintaining a strong quality of product or services. This makes it easier for low-cost businesses to win over customers and out-compete their larger rivals in the marketplace.

Increased Productivity

Low-cost business models lead to increased productivity by streamlining processes and eliminating unnecessary overhead costs. Without the need to maintain expensive offices or staff, low-cost businesses can focus their time and resources on their core mission. Low-cost businesses can also take advantage of technology to automate processes, which further reduces their need to spend money on staff and resources.

Reduced Waste

A low-cost business model also reduces waste. By eliminating the need to maintain excess infrastructure and staff, low-cost businesses can reduce their total output of waste products. This helps reduce their environmental impact and encourages the adoption of sustainable practices. It also reduces their overall costs, making a low-cost business model much more attractive for companies who are looking to reduce their overhead expenses.

Increased Reach

Using a low-cost business model, a company can increase its reach in a number of ways. From gaining access to a wider customer base to the ability to quickly respond to changes in the market, the low-cost business model offers numerous advantages.

Wider Customer Base

A low-cost business model allows companies to target customers on a larger scale. Thanks to the lower costs, companies can spend more of their resources on marketing and advertising, thereby expanding their reach within the customer base and allowing them to attract more customers. The lower-cost business model also enables companies to invest in more products, which further boosts their customer base.

Ability to Quickly Respond to Changes in the Market

The lower costs associated with a low-cost business model also provide companies with the flexibility and agility needed to quickly respond to changes in the market. This allows them to stay competitive and capitalize on opportunities that may arise.

This flexibility also allows companies to experiment with new products and introduce them quickly to the market. This in turn allows them to test their products and services with customers, get feedback, and make adjustments before a product or service is officially launched.

Improved Customer Satisfaction

The success of any business is determined by its ability to satisfy its customers. A low-cost business model has the potential to provide a number of tangible benefits for those it serves.

Lower Costs Provide a Competitive Advantage

Low cost companies have the advantage of being able to offer competitive prices to their customers. Customers can often find better deals because of companies’ ability to keep costs low. A low-cost business model also allows businesses to be more competitive by reducing the cost of goods and services, allowing them to pass those savings on to their customers.

Flexibility in Pricing Practices

A low-cost business model also gives businesses the ability to be flexible in their pricing. Companies can offer discounts and promotions, or they can offer discounted prices to certain customers. This flexibility also ensures that businesses remain competitive while also providing good value to their customers.

The benefits of a low-cost business model are numerous and it is an excellent tool for ensuring customer satisfaction. By keeping costs low and being flexible with pricing, businesses can offer competitive prices to their customers and maintain the loyalty of their customers.

Low-cost business models offer companies a large range of benefits. They allow companies to reduce overhead costs, increase efficiency and profitability, give them more freedom when it comes to managing resources, and make them more competitive in their respective marketplaces. Additionally, low-cost business models can be used to supplement existing services or launch new ones without a huge upfront cost. Ultimately, businesses seeking to gain a competitive edge in their respective industry should consider the advantages of a low cost business model before investing in more expensive alternatives.

Businesses today need to think strategically and invest wisely. Adopting a low-cost business model not only helps you lower overhead costs, but also presents a great opportunity to gain an advantage over your competitors. By engaging in tighter cost control, businesses will be able to improve their bottom line and increase their competitive edge in the marketplace.

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Cost Structure

The Cost Structure is the last – but not least – component of a Business Model . It gathers the most important costs involved in the whole operation from the outset. This is the final block, precisely because we need to have all the previous components already defined so we can estimate the costs of each one. This is because creating a Value Proposition , maintaining a Customer Relationship , and developing Revenue Streams generates costs, just as the Key Resources , Activities and Partners demand their own expenses. Some Business Models, however, are much more cost driven than others. So let’s get to know the role and importance of the Cost Structure for your Business Model.

Cost Driven Businesses vs Value Driven Businesses

Cost-driven business models focus on minimizing any costs wherever possible. They seek, therefore, to create and maintain a cheaper structure, by means of Value Propositions of smaller prices, using processes of automation and outsourcing whenever possible. The goal is to have less expense to generate a more affordable final product. However, it’s worth remembering that a business should only reduce its own costs based on its internal expenses and never in response to what its competition is doing. Anyone who opts for price warfare may face ruin in the marketplace. This is because if the company is not able to manage costs by creating operational efficiency, the low price may become unsustainable. On the other hand, value-driven business models are less concerned with transaction costs and focus on the creation of Value Propositions. These value propositions usually have a high level of customization, developed according to the preferences of the clients. This is the case with luxury hotels, for example, that strive to create an experience for which customers are willing to pay dearly.

Cost structures can have the following characteristics:

• Fixed costs: in these structures, the expenses of the business are always the same, regardless of the size of the production. Costs are time-limited, as is the case with salaries and rentals. And value propositions focus on low price, maximum automation and extensive outsourcing.
• Variable costs : in these structures, the costs depend very much on the volume of production. If you do not produce, for example, there are no variable costs. These costs are therefore sensitive to demand and difficult to predict, as they increase proportionally to the increase in labor and in capital. They involve spending on services and raw materials, for example.
• Economies of scale: here, the larger the volume of production, the lower the total cost per unit. Most large companies with a high production quota are characterized by this cost structure. This is because the total costs are divided by the quantity of articles produced. So the average cost per unit gets smaller. That is why, generally, a larger company has a lower unit cost than a small business. And this saving is usually transferred to the final consumer, who is able to pay a lower price on the market.
• Economies of scope: in this structure, costs are reduced when the company invests in varied markets or in a greater scope of operations. This is because different products share resources and processes. For example, the company already has an ongoing infrastructure, with Marketing, Finance and HR departments, for example, and can enjoy the same organization and only expand the scope, saving in the end. Scope economies offer several advantages, such as: design and product mix flexibility, faster response rate and shorter time to market changes, reduced waste, more accurate change and cycle prediction, more efficient use of software and hardware. In short, there is less risk in a business that sells more than one product and / or segments several markets, since even if the market falters, the company will have more alternatives to sustain itself as it rebalances its strategy.

What to ask when creating a cost structure

When doing a complete analysis of your Business Model, the time will come when you need to establish your own Cost Structure , which matches satisfactorily with each of the previous blocks. To help you with this journey, you can ask yourself the following questions about your venture:

• What are the baseline costs that derive from my business model?
• Which Key Resources can be a heavy expense for the business?
• What Key Activities may require high costs for the business?
• How do your Key Activities generate costs?
• Do these same Key Activities correspond to the Value Propositions chosen?
• When you reconfigure your business model, costs continue fixed or they become variable?
• Is your business more cost-oriented or value oriented?

It is important to note that 90% of new businesses fail in the first three years of life because they have not been able to understand the costs required to develop their Value Propositions. However, when an entrepreneur is able to pinpoint their key resources, key activities and key partners, costs become easier to calculate. And finally, keep in mind that your cost structure should be re-evaluated from time to time, just as the other blocks. This will be the only way to ensure the long-term sustainability of your business.

Daniel Pereira

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Cost Structure: Business Model Canvas Explained

The cost structure is a fundamental component of the business model canvas, a strategic management and entrepreneurial tool that allows businesses to describe, design, challenge, invent, and pivot their business model. The cost structure refers to the total cost a company must incur to operate its business model, create value, deliver value, and generate revenue. This concept is crucial to understanding the financial sustainability and profitability of a business.

Understanding the cost structure of a business model requires a comprehensive analysis of the costs associated with the business's key activities, key resources, and key partnerships. This analysis allows businesses to identify the most cost-intensive areas and to strategize on cost optimization and efficiency . In this article, we will delve into the various aspects of the cost structure, its importance, and how it fits into the business model canvas .

Understanding Cost Structure

The cost structure of a business refers to the types and amounts of costs that a company incurs to operate its business model. These costs can be categorized into fixed costs, variable costs, economies of scale, and economies of scope. Fixed costs are costs that do not change with the level of output or sales, such as rent or salaries. Variable costs, on the other hand, change with the level of output or sales, such as raw materials or direct labor costs.

Economies of scale refer to the cost advantages that a business can achieve by increasing its scale of production, leading to a decrease in per-unit costs. Economies of scope refer to the cost advantages that a business can achieve by producing a wide variety of products or services, leading to a decrease in per-product or per-service costs. Understanding these cost categories allows businesses to strategically manage their costs and improve their profitability.

Fixed Costs

Fixed costs are costs that do not change with the level of output or sales. These costs are incurred regardless of the business's level of activity and are often considered sunk costs because they cannot be recovered once they are incurred. Examples of fixed costs include rent, salaries, insurance, and depreciation. These costs must be paid regardless of the business's revenue or profit levels, making them a critical factor in the business's financial sustainability.

Managing fixed costs is a crucial aspect of strategic cost management . Businesses must carefully consider their fixed costs when designing their business model and pricing their products or services. High fixed costs can create a high break-even point, requiring the business to achieve high sales volumes to cover its costs and become profitable. On the other hand, low fixed costs can allow a business to be profitable at lower sales volumes, providing greater flexibility and resilience.

Variable Costs

Variable costs are costs that change with the level of output or sales. These costs increase as the business's level of activity increases and decrease as the level of activity decreases. Examples of variable costs include raw materials, direct labor costs, and utilities. These costs are directly tied to the business's production or sales volume, making them a critical factor in the business's profitability.

Managing variable costs is another crucial aspect of strategic cost management. Businesses must carefully consider their variable costs when designing their business model and pricing their products or services. High variable costs can erode the business's profit margins, requiring the business to achieve high sales prices to cover its costs and become profitable. On the other hand, low variable costs can allow a business to be profitable at lower sales prices, providing greater competitiveness and profitability.

Cost Structure in the Business Model Canvas

The cost structure is one of the nine building blocks of the business model canvas. It is located on the left side of the canvas, representing the financial aspects of the business model. The cost structure is directly linked to the business's key activities, key resources, and key partnerships, which are also located on the left side of the canvas. This positioning highlights the interdependencies between these building blocks and the cost structure.

The cost structure allows businesses to identify and quantify their most cost-intensive areas, providing a basis for cost optimization and efficiency strategies. By understanding their cost structure, businesses can design a business model that aligns with their strategic objectives and financial capabilities. This alignment is crucial for the business's financial sustainability and profitability.

Link to Key Activities

The cost structure is directly linked to the business's key activities, which are the most important actions a company must take to operate its business model. These activities can include production, problem-solving, platform/network, and more. The cost of these activities constitutes a significant portion of the business's total costs and directly impacts the cost structure.

By understanding the cost of their key activities, businesses can identify cost-intensive areas and strategize on cost optimization and efficiency. This understanding can also inform the business's pricing strategy, as the cost of key activities must be covered by the revenue generated from selling the business's products or services.

Link to Key Resources

The cost structure is also directly linked to the business's key resources, which are the most important assets a company must have to operate its business model. These resources can include physical, intellectual, human, and financial resources. The cost of acquiring, maintaining, and utilizing these resources constitutes a significant portion of the business's total costs and directly impacts the cost structure.

By understanding the cost of their key resources, businesses can identify cost-intensive areas and strategize on cost optimization and efficiency. This understanding can also inform the business's investment strategy, as the cost of key resources must be justified by the value they bring to the business.

Link to Key Partnerships

The cost structure is also directly linked to the business's key partnerships, which are the network of suppliers and partners that make the business model work. These partnerships can include strategic alliances, joint ventures, buyer-supplier relationships, and more. The cost of establishing and maintaining these partnerships constitutes a significant portion of the business's total costs and directly impacts the cost structure.

By understanding the cost of their key partnerships, businesses can identify cost-intensive areas and strategize on cost optimization and efficiency. This understanding can also inform the business's partnership strategy, as the cost of key partnerships must be justified by the value they bring to the business.

Importance of Cost Structure

The cost structure is a critical component of a business's financial health and strategic direction. It determines the business's profitability, competitiveness, and sustainability. A well-understood and well-managed cost structure can provide a business with a competitive advantage, allowing it to offer competitive prices, achieve high profit margins, and sustain its operations in the long term.

The cost structure also provides a basis for strategic decision-making . By understanding their cost structure, businesses can make informed decisions about their business model, pricing strategy, investment strategy, and more. These decisions can have a significant impact on the business's financial performance and strategic direction.

Profitability

The cost structure directly impacts a business's profitability. A business becomes profitable when its total revenue exceeds its total costs. Therefore, managing costs is as important as generating revenue for achieving profitability. By understanding and managing their cost structure, businesses can control their costs, improve their profit margins, and increase their profitability.

Profitability is a key indicator of a business's financial health and success. It is also a key factor in attracting investors, as profitable businesses can provide a return on investment. Therefore, understanding and managing the cost structure is crucial for a business's profitability and financial success.

Competitiveness

The cost structure also impacts a business's competitiveness. Businesses with a low cost structure can offer competitive prices, attracting more customers and gaining market share. On the other hand, businesses with a high cost structure may need to charge higher prices to cover their costs, which can make them less competitive.

Competitiveness is a key factor in a business's market success and growth. It is also a key factor in attracting customers, as competitive businesses can offer better value for money. Therefore, understanding and managing the cost structure is crucial for a business's competitiveness and market success.

Sustainability

The cost structure also impacts a business's sustainability. Businesses with a sustainable cost structure can cover their costs and generate a profit in the long term, ensuring their financial sustainability. On the other hand, businesses with an unsustainable cost structure may struggle to cover their costs and generate a profit, threatening their financial sustainability.

Sustainability is a key factor in a business's long-term success and survival. It is also a key factor in attracting investors, as sustainable businesses can provide a long-term return on investment. Therefore, understanding and managing the cost structure is crucial for a business's sustainability and long-term success.

Strategies for Managing Cost Structure

Managing the cost structure is a strategic task that requires a comprehensive understanding of the business's costs and a strategic approach to cost management. There are several strategies that businesses can use to manage their cost structure, including cost leadership, differentiation, and focus. These strategies can help businesses control their costs, improve their profitability, and achieve their strategic objectives.

Cost leadership involves achieving the lowest cost structure in the industry, allowing the business to offer competitive prices and achieve high profit margins. Differentiation involves offering unique and superior products or services, allowing the business to charge premium prices and achieve high profit margins. Focus involves targeting a specific market segment, allowing the business to optimize its cost structure and pricing strategy for that segment.

Cost Leadership

Cost leadership is a strategy that involves achieving the lowest cost structure in the industry. This strategy requires a focus on efficiency, scale, and cost control. By achieving a low cost structure, businesses can offer competitive prices, attract more customers, and achieve high profit margins.

Cost leadership requires a comprehensive understanding of the business's cost structure and a strategic approach to cost management. This involves identifying cost-intensive areas, implementing cost-saving measures, and monitoring cost performance. By mastering cost leadership, businesses can gain a competitive advantage and achieve financial success.

Differentiation

Differentiation is a strategy that involves offering unique and superior products or services. This strategy requires a focus on innovation, quality, and customer value. By offering differentiated products or services, businesses can charge premium prices, attract more customers, and achieve high profit margins.

Differentiation requires a comprehensive understanding of the business's cost structure and a strategic approach to value creation. This involves identifying value-creating activities, investing in key resources, and delivering superior customer value. By mastering differentiation, businesses can gain a competitive advantage and achieve financial success.

Focus is a strategy that involves targeting a specific market segment. This strategy requires a focus on customer understanding, market insight, and strategic positioning. By targeting a specific market segment, businesses can optimize their cost structure and pricing strategy for that segment, attracting more customers and achieving high profit margins.

Focus requires a comprehensive understanding of the business's cost structure and a strategic approach to market segmentation. This involves identifying profitable market segments, understanding their needs and preferences, and positioning the business to meet those needs and preferences. By mastering focus, businesses can gain a competitive advantage and achieve financial success.

The cost structure is a critical component of the business model canvas and a key factor in a business's financial health and strategic direction. By understanding and managing their cost structure, businesses can control their costs, improve their profitability, and achieve their strategic objectives. This requires a comprehensive understanding of the business's costs and a strategic approach to cost management.

Whether a business chooses to pursue cost leadership, differentiation, or focus, understanding and managing the cost structure is crucial. It allows businesses to make informed decisions about their business model, pricing strategy, investment strategy, and more. Therefore, mastering the cost structure is a key factor in a business's financial success and strategic direction.

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What Is Low-End Disruption? 2 Examples

• 13 Jan 2022

How do successful businesses get pushed out of markets they once dominated? The theory of disruptive innovation—coined by Harvard Business School Professor Clayton Christensen—explains how smaller businesses can disrupt incumbents by entering at the bottom of a market with a low-cost business model.

According to Christensen, who teaches the online course Disruptive Strategy , there are three types of innovation :

• Sustaining innovation , in which a company creates better products to sell for higher profits to its best customers
• Low-end disruption , in which a company enters at the bottom of an existing market and offers a lower-priced product with acceptable performance, ultimately capturing its competitors' customers
• New-market disruption , in which a company creates and claims a new segment in an existing market by catering to an underserved customer base, slowly improving in quality until the incumbent businesses’ products are obsolete

Low-end and new-market disruption are examples of disruptive innovation, differentiated by their relationships with the existing market. New-market disruption occurs when an innovative product creates a new market segment, whereas low-end disruption enters at the bottom of the existing market to provide a “good enough” product to an overserved audience.

Understanding how disruption works can enable you to avoid it if you work at an incumbent business or drive it if you’re a new entrant. Here’s a closer look at one type of disruptive innovation: low-end disruption.

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What Is Low-End Disruption?

Low-end disruption occurs when a company uses a low-cost business model to enter at the bottom of an existing market and claim a segment. As the entrant company claims the lowest market segment, the incumbent company typically retreats upmarket where profit margins are higher.

“Almost always, when low-end disruptions emerge, it creates a situation where the leaders in the industry actually are motivated to flee rather than fight you,” Christensen says in Disruptive Strategy. “That’s why low-end disruption is such an important tool to create new growth businesses: The competitors don’t want to compete against you; they just walk away.”

3 Characteristics of Low-End Disruption

Three characteristics separate low-end disruption from other innovation types:

• It offers “good enough” quality by market standards, but not the best. Customers at the top of the market likely won’t be interested in this product, making it seem non-threatening to incumbent businesses.
• It targets consumers at the bottom of the market. These are people overserved by the current product offerings—that is, they don’t need all the bells and whistles that come with an expensive price tag.
• It makes a profit at lower prices per unit sold than the incumbent businesses. This is essential because, as long as the profit margins are lower than incumbents’ products, they won’t be motivated to fight the entrant for market share. The incumbent businesses’ pursuit of profit is the causal mechanism that enables entrants to continue to move upmarket.

Related: 3 Examples of Disruptive Technology That Are Changing the Market

2 Examples of Low-End Disruption

Low-end disruption happens more often than you might think. Some of your favorite brands likely had to disrupt an incumbent business to get where they are today.

“[Low-end] disruption is how Canon attacked Xerox,” writes Christensen in The Huffington Post , “how Walmart and Target bested the department stores; how Southwest drove so many major airlines into bankruptcy; how Sony defeated RCA, and how Apple crippled Sony.”

Here are two examples of low-end disruption that offer insights for both new entrants and incumbent businesses.

1. 3D-Printed Real Estate

A low-end disruption emerging in the real estate construction market is 3D printing technology. 3D printers use digital files as blueprints to deposit layer upon layer of material—often concrete—in a specific design to construct a building.

A 3D-printed two-bedroom home can cost between $4,000 and $10,000 to construct, much less expensive than homes built using manual labor. Because 3D printers can create a home on-site, transportation fees are eliminated. Labor costs are also much lower compared to traditional construction jobs because the machine does all the hard labor. This also cuts the risk of costly human error and instances of injury. Despite the price of the 3D printer itself, this method of constructing homes is extremely cost-effective.

This low-cost method of building houses is most useful in deeply impoverished and disaster-stricken areas. The people in need of homes in those places don’t need fancy, large, or architecturally beautiful houses—they just need structurally sound homes.

3D printing has entered at the bottom of the real estate construction market, claiming the lowest segment: people who need homes that are “good enough.”

There’s speculation that 3D printing construction companies may continue to move upmarket, improving the quality of 3D-printed homes as they do so. By using a low-cost business model, 3D printing construction companies can motivate incumbent manual construction companies to flee upmarket. This disruptive technology is one to watch.

2. Toyota and General Motors in the Auto Industry

Another example of low-end disruption is Toyota’s entrance into the automobile industry. Up until 1957, General Motors (GM) controlled half of the United States auto market and was making strides internationally. GM’s strategy was to create a breadth of products to appeal to many audience types.

Toyota, a Japanese car manufacturer, released its first model—called the Corona—in 1957. The Corona wasn’t a luxury car, instead appealing to customers at the bottom of the auto market. It was a “good enough” vehicle at a reasonable price.

General Motors had models that targeted wealthier customers willing to pay for higher-quality cars, so it wasn’t motivated to fight Toyota for share of the lowest market segment.

Over the years, Toyota released new models—the Tercel, Corolla, Camry, Avalon, and 4-Runner—appealing to higher market segments and pushing GM further upmarket. Eventually, Toyota released the Lexus, a high-quality, luxury car that directly competed with GM for the highest market segment. This is near-successful low-end disruption.

The interesting twist is that GM survived—although not without losing billions of dollars and, eventually, CEO Rick Wagoner. In typical low-end disruption scenarios, the incumbent company is pushed out of the market by the disruptor and fails. GM, however, shifted its focus to the bottom of the market and produced small, energy-efficient vehicles when backed into the industry’s highest profit market segment. Poised to be disrupted, GM repositioned itself as the disruptor.

Because low-end disruption requires a business model that yields a lower profit than incumbent companies’—in addition to an economic recession—GM’s profits took a nosedive to the tune of $85 billion. When the company filed for bankruptcy in 2009, Wagoner asked the US government for funding to get it back on its feet. The government granted it with the condition that Wagoner resign.

Christensen disagrees with the forced resignation of a manager who successfully led a company through disruption.

“In reality, the decisions to retreat upmarket in the face of disruptive attack were made at General Motors in the 1970s and 80s by CEOs Thomas Murphy and Roger Smith,” Christensen writes in The Huffington Post . “Wagoner inherited the legacy of their having ignored the disruptive nature of the threats they faced. He and his team have done a remarkable job of working out of it—though much remains to be done.”

Under new management, GM remains one of the world’s most powerful auto companies, thanks in no small part to Wagoner’s decision to disrupt the disruptor rather than be extinguished.

Crafting Strategies for Disruption

These examples offer nuggets of wisdom for both entrants and incumbents. Still, one lesson rings true for both: A foundation in the theory of disruptive innovation can be the difference between a business that survives and one that fails.

Whether you’re approaching disruption from the perspective of an incumbent business or a new entrant, learning about types of disruptive innovation can enable you to craft strategies to prepare for or drive disruption.

Are you interested in driving innovation for your organization? Explore our six-week course Disruptive Strategy to learn the tools, frameworks, and intuition to develop winning strategies.

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Cost Structure in Business Model Canvas: The Cornerstone for Building a Profitable Business Model

Published: 19 July, 2023

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Businesses often struggle with managing their finances. With a great idea and a great product or service, it’s easy to just assume all the bills will get paid and everything will turn out all right. People who start businesses are energized by the value they’re delivering but are measurably less enthusiastic when it comes to actually running the business.

Understanding how a business’s Cost Structure influences the entirety of the operation is essential for ensuring the company’s success. Seeing it at work within a larger Business Model Canvas helps put your Cost Structure into the proper context.

In this article, we discuss the role of Cost Structure in your overall business model, and how adjusting it is an important site of innovation loaded with possibilities. We touch on some of the reasons why Cost Structure plays such a vital role in business innovation. We also discuss some ways to alter your Cost Structure to make innovation and transformation possible. The experts at Digital Leadership have plenty more to say about all of this, so don’t hesitate to reach out through our website.

Cost structure definition

Cost Structure refers to all the ways a business approaches paying its bills, such costs take many forms: the fixed cost of building rental, the variable cost of hourly wages, the sometimes-unpredictable costs of repairs or disaster response.

How a business prepares for fixed and variable costs, overhead expenses, production supplies, and any number of other concerns must be completely reflected in its cost structure.

Cost Structure is the aggregate of all the ways a business must spend money. Companies can use Cost Structure within an overall Business Model to identify where expenses can be reduced.

Cost Structure in Business Model Canvas

Cost structures play a key role in the Cost Model of your Business Model Canvas. The cost structure concept helps guide how you target innovation and value proposition development. Through understanding cost structures, you can aim to reduce costs, as well as make the most from every cost your business incurs.

Business Model Canvas Building Blocks

Cost Structure is just one of the many building blocks of the Business Model Canvas. It’s useful in understanding the overall impact of Cost Structure to consider the remaining fields in the Canvas.

We’ve written about the Business Model Canvas Building Blocks before, so they are presented here only briefly. Unlock the full potential of your business and gain a deeper understanding of your cost structure with The UNITE Business Model Canvas. This powerful and innovative framework offers a comprehensive approach to visualizing and analyzing your cost-related aspects within the context of your entire business model. By using the UNITE Canvas, you can identify cost drivers, allocate resources efficiently, and uncover opportunities for cost optimization. You can download it now!

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Related Article: Business Model Canvas 101: Everything You Need to Know to Succeed

(1) Key Resources

A list of your Key Resources, which can be categorized into physical, financial, intellectual property, and unique people skill sets. Their placement in the Business Model Canvas ensures that we give them full consideration from multiple angles.

(2) Key Activities

Your Key Activities should never be outsourced: they’re far too important. But other, tangential activities that are necessary though not at the core of your business (copy machine maintenance, for example) can be handled by contractors or other outside entities.

(3) Key Partners

Without your Key Partners , your Core Activities would be impossible. Relationships with your Key Partners, therefore, are vital to your success and should be nurtured and cared for appropriately.

(4) Distribution Channels

Rarely does a company deliver its goods or services to customers without some third-party distribution channels . Understanding the role Distribution Channels play in how we deliver value to our customers is important to understanding the overall Business Model.

(5) Customer Relationships

Different businesses have different relationships with their customers, but they should never be positioned in opposition to each other. The clearest way of ensuring proper attention is paid to Customer Relationships is through the Jobs to be Done framework , which is a major segment of the UNITE eXtended Business Model Canvas.

(6) Customer Segments

Personas help you understand who your customers are as people within their broad segments so you can better reach them and bring them value. Through them, you differentiate between different customer segments.

(7) Revenue Streams

Revenue Streams outline how you earn money. A Business Model can involve transactional revenues resulting from one-time customer payments (e.g., a sale) or recurring payments (e.g., a subscription).

(8) Value Proposition

It helps to project, test and build the business Value Proposition in a more structured and reflective way, just as the Business Model Canvas helps you do so during the process of designing a Business Model. Including the Value Proposition Canvas as an element of the more extensive Business Model Canvas helps give you full visibility into your plans. It’s more than worth the added effort.

Cost Structure Examples

The Cost Structure is a key component of the Business Model Canvas (BMC), a strategic management tool used to describe and analyze a business model. It outlines the major costs and expenses associated with operating a business. Here are some examples of cost structures that businesses may encounter:

• Rent or Lease Payments: The cost of renting office space or a manufacturing facility.
• Salaries and Benefits: Regular salaries paid to employees and associated benefits such as insurance and retirement contributions.
• Insurance: Business liability insurance, property insurance, etc.
• Depreciation: The allocation of the cost of assets over their useful life.
• Utilities: Regular expenses for electricity, water, gas, internet, etc.
• Raw Materials: Costs associated with purchasing materials to produce goods.
• Manufacturing Costs: Expenses related to the production process, such as direct labour costs.
• Sales Commissions: Payments made to sales representatives based on the volume of sales.
• Shipping and Freight: Costs for delivering products to customers.
• Cost of Goods Sold (COGS): The direct costs of producing goods or services sold by a company.
• Marketing and Advertising: Promotional costs to attract customers and increase brand visibility.
• Research and Development (R&D): Expenses related to developing new products or improving existing ones.
• IT Infrastructure: Costs associated with maintaining computer systems and software.
• Customer Support: Resources allocated to assist customers with inquiries or issues.
• Office Supplies: Expenses for basic supplies necessary for office operations.
• Marketing Campaigns: Costs associated with advertising and promotional activities to attract new customers.
• Sales Team Expenses: Salaries, commissions, and other costs related to the sales team’s efforts to acquire customers.
• Free Trials or Discounts: Costs incurred from offering free trials or discounts to entice new customers.
• Warehousing: Expenses related to storing and managing inventory.
• Distribution Channels: Costs associated with utilizing third-party distributors or sales channels.
• Warranty and Repairs: Costs related to honouring warranties and repairing or replacing defective products.
• Customer Service: Expenses for assisting customers with post-sale inquiries or issues.

Differentiating Cost Structure Types for Your Business

There’s a good chance you don’t know, at least not in a formal way. To be successful, Cost Structures need to be intentional. Unless you’ve made a selection and followed through, you’re probably experiencing unnecessary costs.

What are the different Cost Structures that might appear in your Business Model Canvas? Let’s look at some.

(1) Fixed Cost Structure

The most predictable kinds of costs are Fixed Costs, and a Fixed Cost structure is useful for many types of businesses.

Definition & Explanation

These are costs incurred no matter how many goods or services the business produces. These costs tend to be recurring, like rent, insurance, or loan payments. A fixed cost is usually predictable.

Fixed costs are often capital investments and other overhead costs.

Advantages and Disadvantages

Many of the advantages and disadvantages of a Fixed Cost Structure centre around the consistency and the constancy associated with this approach.

Some advantages of fixed costs in a business plan are:

• Budgeting predictability: Fixed costs provide a level of predictability in budgeting and financial planning, as they remain constant regardless of changes in sales or production levels.
• Planning stability: Fixed costs provide stability to a business plan and make it easier to plan for the future.
• Cost control: Fixed costs allow businesses to control costs better by ensuring that a set level of expenses is incurred each period, regardless of fluctuations in sales or production.
• Price setting: Fixed costs provide a basis for setting prices, as they are a known and constant expense that must be covered by sales.
• Investment justification: Fixed costs can be used to justify investment in long-term assets, as they provide a predictable ongoing expense for the life of the asset.

Some disadvantages of fixed costs in a business plan are:

• Inflexibility: Fixed costs are set and cannot be easily adjusted, making it difficult to respond to changes in market conditions or demand.
• Predictability: Fixed costs can be difficult to predict, making it challenging for businesses to accurately forecast their expenses.
• High burden: Fixed costs can place a high financial burden on a business, especially if sales are slow or there is a downturn in the market.
• Limited resources: Fixed costs can tie up a significant portion of a company’s resources, leaving less available for investment in growth opportunities.
• Cash flow challenges: Fixed costs can strain a company’s cash flow, making it difficult to meet regular expenses or make investments in the business.

(2) Variable Cost Structure

Not all costs are as predictable as Fixed Costs. When costs are subject to (sometimes large or quick) changes, these are Variable Costs, and like a Fixed Cost Structure, a Variable Cost Structure has its uses and challenges.

A variable cost changes in relation to how many goods or services the business provides. While these costs can be predictable if the business is planning properly, they are not the same from one period to the next.

Variable costs include direct labour costs, direct materials costs, and maintenance payments.

Advantages of variable costs in a business plan’s cost structure include:

• Flexibility: Variable costs can change as production levels change, allowing businesses to adjust their costs to meet fluctuations in demand.
• Predictability: Variable costs are often directly tied to a specific unit of output, making it easier to predict the cost of production.
• Improved profitability: Since variable costs change as production levels change, businesses can increase their profitability by reducing their costs as production slows down or by increasing production to take advantage of favourable market conditions.
• Better cost control: By focusing on controlling variable costs, businesses can improve their overall cost structure and achieve better margins.
• Increased focus on efficiency: Because variable costs are directly tied to production, businesses are encouraged to focus on improving their processes and becoming more efficient to reduce their costs.

Disadvantages of variable costs in a business plan’s cost structure include:

• Volatility: Variable costs can be subject to fluctuations, which can make it difficult for businesses to plan and budget accurately.
• Lack of control: Variable costs are often outside of a business’s control, such as raw materials prices, which can lead to unexpected cost increases.
• Difficulty in planning: Because variable costs can change frequently, it can be challenging to accurately forecast expenses and plan for future production.
• Increased risk: Businesses with a high proportion of variable costs may be at a higher risk of financial instability, as their costs can change quickly and unpredictably.
• Reduced stability: Since variable costs change with production levels, businesses with a high proportion of variable costs may experience significant financial swings, which can reduce stability and make it difficult to maintain a consistent cash flow.

(3) Hybrid Cost Structure

Some businesses are in a position that lets them have a blend of Fixed and Variable costs.

In reality, most businesses have both types of costs in one way or another. But in a Hybrid Cost Structure, businesses are making an explicit choice to be sure to utilize both Fixed and Variable costs.

A Hybrid Cost Structure refers to a business model that combines elements of both fixed and variable cost structures. In this model, some costs are fixed and do not change with changes in output or sales volume, while others are variable and increase or decrease with changes in output or sales volume.

With a Hybrid Cost Structure, businesses try to balance the benefits of stability and predictability offered by fixed costs with the flexibility and responsiveness offered by variable costs.

The advantages of a hybrid cost structure in a business plan cost structure include the:

• Improved predictability: By combining both fixed and variable costs, a hybrid cost structure allows businesses to have a more accurate understanding of their costs, which can improve their ability to forecast expenses and plan for future production.
• Better cost control: A hybrid cost structure gives businesses greater flexibility to control their costs, as they can adjust their variable costs based on changes in production levels while maintaining a stable base of fixed costs.
• Increased stability: By having a mix of fixed and variable costs, businesses can reduce the volatility in their cost structure and achieve a more stable financial position.
• Improved cash flow management: A hybrid cost structure allows businesses to better manage their cash flow, as they have a predictable base of fixed costs, which can help with budgeting and planning.
• Increased flexibility: A hybrid cost structure allows businesses to adjust their cost structure in response to changes in the market or changes in their production levels, which can increase their ability to respond to new opportunities or challenges.

Disadvantages of a hybrid cost structure in a business plan’s cost structure include:

• Complexity: A hybrid cost structure can be more complex to understand and manage than a purely fixed or variable cost structure, which can make it more difficult for businesses to plan and budget accurately.
• Increased difficulty in forecasting: Because a hybrid cost structure involves both fixed and variable costs, it can be challenging to accurately forecast expenses and plan for future production.
• Reduced focus on efficiency: A hybrid cost structure may result in businesses having a reduced focus on efficiency, as they have a mix of fixed and variable costs, which can lead to complacency in cost management.
• Increased overhead costs: A hybrid cost structure can result in increased overhead costs, as businesses may need to invest in additional resources to manage the complexity of their cost structure.
• Less straightforward cost structure: A hybrid cost structure may not be as straightforward as a fixed or variable cost structure, which can make it more difficult for stakeholders to understand the financial position of the business.

Factors to Consider When Choosing a Cost Structure

Like everything else in your enterprise, your Cost Structure will depend upon a combination of factors unique to your business. Let’s unpack some of the factors you should keep in mind when deciding upon your business’s Cost Structure.

(1) Business size and stage of development

Larger businesses typically have a more complex cost structure, with a larger proportion of fixed costs and a greater number of employees and operational expenses. On the other hand, smaller businesses tend to have a simpler cost structure, with a greater proportion of variable costs and lower overhead expenses.

Additionally, as your business grows and becomes more established, you may see a shift towards a higher proportion of fixed costs as you invest and expand.

Understanding how your business and its interests will change over time will help you recognize the need to change your Cost Structure.

(2) Industry type and competition

Different industries have different cost considerations based on factors such as the price of raw materials, the level of regulation, and the type of products or services offered. For example, a manufacturing company may have a higher proportion of variable costs to take into account the change in price of raw materials, while a service-based company may have a higher proportion of fixed costs as it projects employee compensation.

Competition can impact a company’s cost structure as businesses compete to offer the lowest prices or the highest quality products and services. You may need to make adjustments to how you do business based on others in your sector or changing beliefs in the marketplace.

(3) Product or service offered

If you are a business offering a product, then your cost structure will be influenced by the labour and raw materials that go into manufacturing. You may also experience shifts in costs to deliver your goods to consumers, a reality that was felt particularly acutely during the height of the global COVID-19 pandemic. Businesses that plan for shifts in these costs are much more robust than their competition.

If you are offering a service, while you may have some costs for materials, your main cost will be employee compensation. These are generally predictable, allowing you to plan for a somewhat stable future.

(4) Market demand and customer behaviour

Finally, the demand for your product or service will influence your costs. You’ll need to find the balance between economy of scale and not over-stocking supplies.

A business can use variable pricing strategies to align its costs with changes in customer demand. For example, a business may offer discounts or promotions to encourage higher sales during slow periods or increase prices during periods of high demand to maximize its revenue potential. You can plan for these, taking advantage of current trends and the availability of resources.

Cost Structure is an important component of your Business Model, so understandably, it features in the Business Model Canvas as well as other useful planning tools.

When considered properly, your Cost Structure is another aspect of your business ripe for innovation and development.

Frequently Asked Questions

1- can a business change its cost structure over time.

Of course, a business can change its Cost Structure over time. As the business matures, or as the marketplace changes, Cost Structure should always be considered as an opportunity for innovation to leverage competitive advantages.

2- What are the 8 types of cost?

• Direct Costs: Expenses directly linked to producing a specific product or service.
• Indirect Costs: Overhead expenses supporting overall business operations.
• Fixed Costs: Constant expenses, unaffected by changes in production or sales.
• Variable Costs: Fluctuate based on changes in production or sales volume.
• Operating Costs: Day-to-day expenses necessary for running the business.
• Opportunity Costs: Potential benefits lost when choosing one alternative over another.
• Sunk Costs: Expenses already incurred and irrecoverable.
• Controllable Costs: Expenses that can be managed or influenced by specific individuals or departments.

3- What are some common mistakes businesses make when it comes to Cost Structure?

The first mistake many businesses make in regard to Cost Structure is not thinking about it at all. Cost Structure is an integral piece of your overall Business Model, which is why it’s included in tools like the Business Model Canvas.

The next common mistake businesses make is that they are often too entrenched in the status quo. Evaluating your Cost Structure should be a piece of your overall innovation plan.

4- Can a business have multiple Cost Structure types for different products or services?

Yes, some Cost Structures are more appropriate than others for different Business Models.

5- What are cost structures in marketing?

In marketing, the cost structure refers to the breakdown of expenses incurred in the process of promoting and selling products or services. Understanding the cost structure in marketing is essential for businesses to allocate resources efficiently and make informed decisions regarding their marketing strategies. Here are some key elements of the cost structure in marketing:

• Advertising and Promotion: Expenses for online and offline advertising, and promotional materials.
• Marketing Personnel: Salaries, bonuses, and training for marketing and sales teams.
• Market Research and Analysis: Costs for gathering consumer insights and market research.
• Digital Marketing Tools: Expenses for using digital marketing platforms and software.
• Content Creation: Costs for producing marketing content like blogs, videos, and infographics.
• Events and Trade Shows: Budget for participating in trade shows and events.
• Distribution and Sales: Expenses related to product distribution and sales efforts.
• Public Relations: Costs for PR agencies or in-house PR activities.
• Influencer Marketing: Expenses for collaborating with influencers.
• Social Responsibility: Costs for cause-related marketing efforts.
• Testing and Experimentation: Budget for trying new marketing strategies.
• Affiliate Marketing: Costs associated with affiliate commission payments.

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What Is The Cost Structure Of A Business Model And Why It Matters

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.

Table of Contents

Why it’s important to know how companies spend money

There are two elements to understand about any company:

• How it makes money.
• How it spends money.

While most people focus on how companies make money. A few truly grasp how those same companies spend money.

However, understanding how companies spend money can give you insights into the economics of their business model .

Thus, once you grasp those two – seemingly simple – elements you’ll understand a good part of the logic behind the company’s current strategy .

Defining and breaking down the cost structure

In the  business model canvas by Alexander Osterwalder , a cost structure is defined as:

What are the most cost in your business? Which key resources/ activities are most expensive?

In other words, the cost structure comprises the key resources a company has to spend to keep generating revenues.

While in accounting terms, the primary costs associated with generating revenues are called COGS (or cost of goods sold).

In business modeling , we want to have a wider view.

In short, all the primary costs that make a business model viable over time are good candidates for that.

Therefore, there is not a single answer.

For instance, if we look at a company like Google, the cost structure will be primarily comprised of traffic acquisition costs, data center costs, R&D costs, and sales and marketing costs.

Why? Because all those costs help Google’s business model keep its competitiveness.

However, if we had to focus on the main cost to keep Google making money we would primarily look at its traffic acquisition costs (you’ll see the example below).

This ingredient is critical as – especially in the tech industry – many people focus too much on the revenue growth of the business.

But they lose sight of the costs involved to run the company and the “price of growth .”

Defined as the money burned to accelerate the rate of growth of a startup.

Too often startups burn all their resources because they’re not able to create a balanced business model , where the cost structure can sustain and generate enough revenues to cover the major expenses and also leave ample profit margins.

Companies like Google have been pretty successful in building up a sustainable business model thanks to their efficient cost structure.

Indeed, from a sustainable cost structure can be built a scalable business model .

Operational scalability

In the Blitzscaling business model canvas , to determine operational scalability, Reid Hoffman asks:

Are your operations sustainable at meeting the demand for your product/service? Are you revenues growing faster than your expenses? 

Blitzscaling is a particular process of massive growth under uncertainty that prioritizes speed over efficiency and focuses on market domination to create a first-scaler advantage in a scenario of high uncertainty.

Reid Hoffman uses the term operational scalability as the ability of a company at generating sustainable demand for its products and services while being profitable.

Indeed, lacking the ability to build operational scalability represents a key growth limiter, and the second key element (together with lack of product/market fit ).

While most startups’ dream is to grow at staggering rates. Growth isn’t easy to manage either.

As if you grow at a fast rate, but you also burn cash at a more rapid rate, chances are your company or startup might be in jeopardy.

That is why a business model that doesn’t make sense from the operational standpoint is doomed to collapse over time!

Cost structure and unit economics

A cost structure is an important component of any business model, as it helps to assess its sustainability over time.

While a startup’s business models, trying to define a new space might not be able to be profitable right away, it’s important to build long-term unit economics.

Google cost structure case study

I know you might think Google is too big of a target to learn any lessons from it.

However, the reason I’m picking Google is that the company (besides its first 2-3 years of operations) was incredibly profitable.

Many startups stress and get hyped on the concept of growth . However, it exists a universe of startups that instead managed to build a sustainable business model .

Google is an example of a company that came out of the ashes of the dot-com bubble thanks to a hugely profitable business model :

To appreciate Google’s business model strength, it is critical to look at its TAC rate .

TAC stands for traffic acquisition costs, and that is a crucial component to balance Google’s business model sustainability.

More precisely the TAC rate tells us the percentage of how Google spends money to acquire traffic, which gets monetized on its search results pages.

For instance, in 2017 Google recorded a TAC rate on Network Members of 71.9% while the Google Properties TAX Rate was 11.6%.

Over the years, Google managed to keep its cost structure extremely efficient, and that is why Google has managed to scale up!

Part of Google’s cost structure is useful for keeping together the set of processes that help the company generate revenues on its search results pages, comprising:

• Server infrastructure: back in the late 1990s when  Google was still in the very initial stage at Stanford, it brought down its internet connection several times, causing several outages. That allowed its founders to understand they needed to build up a robust infrastructure on top of their search tool. Today Google has a massive  IT infrastructure made of various  data centers  around the world.
• Another element to allow Google to stay on top of its game is to keep innovating in the search industry. Maintaining, updating, and innovating Google‘s algorithms isn’t inexpensive. Indeed, in 2021 Google spent billions on R&D .
• The third element is the acquisition of continuous streams of traffic that make Google able to create virtuous cycles and scale up.

How do we judge the ability of Google’s advertising machine ? 

I envisioned a metric called traffic monetization multiple, which is the ability of the company to monetize its traffic: 

As you can notice from the above, this is a purely financial metric, which needs to be balanced out with a qualitative analysis of why the metric increased in the first place. 

Indeed, it’s critical to keep into account these questions: 

• Has monetization increased thanks to an improved UX?  Or is monetization worsening the UX?
• Has monetization improved thanks to an increased customer base? Or has it increased due to higher prices per ad?
• Lastly, how is monetization balanced with legal risks posed by increased tracking? 

All these questions are critical to answer, because, financially Google’s advertising machine seems as strong as ever.

There are hidden risks underlying it, which might, all of a sudden threaten its overall business model. 

• On a positive note, Google has managed to further scale, as a consequence of the pandemic. Thus, bringing its products to hundreds of millions of new users. Yet. this further scale (especially on mobile devices) has created new challenges for the company. Which is finding it harder and harder to properly index a web made of billions and billions of pages, and growing. This poses a threat in the long term, as it might reduce the quality of organic search results.
• To monetize this expanded user base, Google is serving more ads. This might work in the short term to squeeze the advertising machine. But it might make the overall experience bad in the long term. So it’s critical to balance these things out. 
• To further expand its revenues, the company has also increased the price per ad. While, in the short-term, the strategy works, in the long-term, this might substantially reduce the customer base. 

The points above, are some of the things you want to look at, qualitatively, to really understand what’s going on, with the changing cost structure of the company. 

Netflix cost structure case study

When we look at the overall Netflix business model it’s important to understand a couple of things in order to frame its cost structure: 

• The Netflix revenue model .
• And the Netflix capital expenditure. 

Netflix runs an on-demand streaming platform, on top of a subscription service.

Members pay a fixed subscription monthly or yearly price, in exchange for having access to a library of content that continuously updates. 

If Netflix revenues are higher than the cost that it takes to run the platform, then the platform is profitable. 

Is Netflix profitable? It is indeed. However, to understand its cost structure we need to have a deeper look at Netflix’s capital expenditure.

In short, in order for Netflix to keep generating revenues in the long-term, it needs to have a library of content that is guaranteed in the coming 5-10 years.

How can the company do that? 

It can do that by either licensing or producing content.

Those mechanisms have two different dynamics. 

In fact, for most of its life, Netflix has been spending a massive amount of resources to license content and make it available on its platform.

This is the epitome of a platform business model . 

Thus, Netflix invested capital to guarantee a continuous flow of content on top of its platform.

This advanced capital would be repaid back, with revenues coming from memberships.

This also means that for most of its history Netflix run at a negative cash flow cost structure.

Meaning that Netflix had to advance the money needed to license the content.

This money would be recouped many times over, in the long run, as the platform kept growing its members’ base. 

On the other hand, starting in 2013, Netflix started to invest more and more into produced content.

What we know today as “Netflix Originals” or a library of content exclusive to paying members. 

This sort of investment, while similarly, to licensing content, makes Netflix advance the costs of content, which would be recouped over the years.

It also gives the company the ability to freely distribute this content and dispose of this content over the years. 

In conclusion, even though the content production investment doesn’t change the Netflix cost structure in the short term, it will change it in the long run.

Thus, we might expect Netflix to move from a cash flow negative cost structure, to a cash flow positive cost structure as it moves from the platform (investing primarily in licensed content) to a media powerhouse (as investments in produced content pass those in licensed content). 

Thus, what I like to call “the mediafication” of Netflix, will be a key component of its business model advantage, in the long term.

How do we assess the evolution in this process?

This process of “mediafication” started in 2013. And while today, 66% of the content investments on Netflix are still about licensed content, the company is ramping up its investments in owned content, further. 

From a formal standpoint, when new content investments in produced content will pass the license ones, we can officially call Netflix a Media Powerhouse! 

And for now, it’s critical for the company to keep “arbitrating content:”

Amazon cost structure case study

When we look at the overall Amazon business model it’s important to understand a couple of things in order to frame its cost structure: 

• The Amazon revenue model .
• And Amazon’s capital expenditure. 

When it comes to Amazon, in particular, understanding its cost structure is a bit trickier, as the company runs a business model with many moving parts, business units, and cost structures. 

In fact, it’s important to look at Amazon’s business model, according to two perspectives: 

• Amazon e-commerce platform (everything that runs on top and adjacent to Amazon e-commerce).
• And Amazon Enterprise/B2B platform (Amazon AWS). 

When it comes to the Amazon e-commerce platform, its primary mission is to enable variety, low costs, and a great customer experience. 

Thus, Amazon runs it (as a choice) with very tight profit margins. However, this doesn’t give us a complete picture of its e-commerce cost structure.

Indeed, while the Amazon e-commerce platform has tight profit margins, it still runs with a widely positive cash flow structure. 

How? Through its cash conversion cycle:  

In short, Amazon is able to turn its inventories very quickly, get paid quickly by customers, and pay back suppliers with a wider term, thus enabling the company to generate wide cash margins, in the short-term, invested back into the business. 

When instead, we look at Amazon’s Enterprise/B2B platform, Amazon AWS , we need to frame this in a different light:

You can see how over the years Amazon AWS profitability has been running at wide margins. As the infrastructure costs are well paid for, from its revenues. 

This is true also today (2021), where Amazon AWS contributed to 55.5% of the overall Amazon operating margins.

This means, that if you were to spin off Amazon AWS from Amazon’s operations, you would get a much lower operating profit figure. 

Amazon AWS, while also requiring substantial technological investments, for now, it enjoys market dominance (In 2021 Amazon AWS had revenues of over $62 billion, whereas Microsoft Intelligent Cloud, for over $60 billion, and Google Cloud, for over $19 billion) and wide margins, which might last over the next 5 years, as more startups move to AI, as a core paradigm of software companies (Amazon AWS is becoming the leading infrastructure powering up the AI and software industry). 

Spotify’s Cost Structure Analysis Case Study

When we look at Spotify’s cost structure, it’s important to emphasize the difference between the two main revenue streams: 

• Ad-supported:  free users can get unlimited music for free, but they have limited options and features. For instance, before they can skip listening to new songs or podcasts they will have to listen to the advertising. Thus advertising amortized the cost of Spotify to run the platform for free users.
• Premium:  free users are channeled through a self-serving funnel that prompts them to subscribe to the paid service. Thus, enabling Spotify to monetize at wide margins the free platform, once free users become paid subscribers. 

When it comes to cost structure, therefore, it’s worth noticing: 

• The ad-supported business runs at tight margins, and its cost gets amortized with advertising. However, the free platform is used as a self-serving funnel to prompt free users to become paid members. In fact, chances are – if you are a paid member – you were a free user before. In short, being a free user widely increases the chances of becoming a paid member. 
• The premium business, while it has a lower subscriber count, it has much wider margins. Thus, the premium platform widely pays off for the free platform. 

In other words, in this specific case, the cost structure analysis helps us frame the importance of the free platform. 

As if we were to analyze that from the perspective of revenues along, the free platform would not be justified.

In fact, the free platform has tight margins, and it generates costs the more it widens up.

In fact, the more free users on the platform, the more royalties Spotify has to pay back to creators for the streamed content. 

Instead, the free platform needs to be judged beyond revenue generation along. And the cost structure analysis of the premium members helps us assess that. 

The free users’ platform is critical to enhancing Spotify’s sales model, thus increasing the chances of free users becoming paid members.

And it plays a key role to enhance the brand and visibility of Spotify, as a consumer platform. 

In short, chances are that if to become a premium member, you were a free member first.

Therefore, on the one hand, the ad-supported business is key to amplifying the brand of the company.

On the other hand, the ad-supported business is critical to funneling free users into premium members. 

That is why, it’s important to perform bot a revenue model analysis, combined with a cost structure analysis. 

To understand the reasons for running certain business segments, that go beyond revenues alone. 

Apple: how much does an iPhone cost?

Another incredible example, of how a cost structure changes according to a business model, it’s Apple. 

Apple has been among the few companies that managed to build one of the most incredible business platforms of the last fifteen years. 

Indeed, we can argue, that Apple is the major business platform of the last fifteen years (since on Stage, in 2008, Steve Jobs announced the App Store, after having announced it almost a year before the iPhone). 

Of course, when it comes to Apple we can easily argue that its business model depends too much on its iPhone sales and that the company managed to keep its manufacturing costs for the iPhone, by outsourcing most of the manufacture in China, while keeping the design in-house. 

And those are all true facts. 

Yet, Apple is the only company that managed to build such a massive business, at scale, on a device, which turned into a platform. 

This completely affected the company’s cost structure. 

First, let me explain what’s the difference between a product and a platform. 

A product is simply a physical/digital thing that can be exchanged from the company to the customer. 

A platform, instead, is something that goes beyond the physical/digital product itself, and it gains value based on the utility that can grow exponentially, of the underlying product. 

This utility comes from the fact, that other people (developers, and entrepreneurs) can extend and expand the capability of the product to design features and a whole set of applications that final users find compelling.

When the iPhone transformed from a product (in 2007) to a platform (in 2008), that was the turning point. 

You no longer get a commodifiable good, which over time would depreciate. 

Instead, thanks to the fact that the iPhone became de facto the dominating mobile platform of the last fifteen years, it enabled Apple to use a reverse razor strategy . 

In other words, other players had to gain market shares by decreasing the price of their products. 

Apple could keep growing by increasing the price of the iPhone, as its utility (thanks to the App Store) grew. 

This deeply affected Apple’s cost structure. 

Where the company managed to keep its cost of making the iPhone low, while keep increasing its prices, as utility grew.

In addition to that, Apple successfully built a service business, on top of the iPhone, thanks to its market strength. 

The service business further expanded on top of the iPhone dominance and it’s now become among the most important revenue streams for Apple. 

For that, it’s critical to look at the evolution of Apple’s business model . 

Today the App Store represents a 30% tax on the mobile web, which Apple is able to keep cashing out on, thanks to the success of hardware + software (Operating System) + Marketplace (App Store) what today we know as a Business Platform!

Key takeaway

You need to understand two key elements to have insights into how companies  “think” in the current moment.

The first is how they make money.

The second is how they spend money.

When you combine those two elements, you can understand the following:

• How a company really makes money (where is the cash cow, and how and if a company lowers its margins to generate more cash flow for growth ).
• Whether that company is operationally scalable.
• Where the company is headed in the next future and whether it will make sense for it to invest in certain areas rather than others!

In this article, we focused on operational scalability and cost structure, and we saw how Google managed to build an extremely efficient cost structure.

Additional Cost structure examples

Here are some more cost structure examples from a few well-known companies.

According to Statista, Walmart has a total of almost 11,000 stores around the world with a sophisticated and optimized supply chain.

The company benefits from a cost-driven structure characterized by economies of scale and scope, but it nevertheless must meet numerous expenses.

One of the main costs Walmart must absorb is labor. This is no surprise since the company at one point was the third largest employer in the world after the United States and Chinese armed forces.

Employee wages are the main component of the labor costs, but the company’s strong anti-union stance means it is frequently embroiled in various legal disputes over worker rights.

The company also spent $107.1 billion on selling, general, and administrative expenses in 2019 (around 20.5% of total revenue).

Cost of sales for the same period was $385.3 billion, which includes the cost of product transportation, warehousing, and import distribution .

As a premium manufacturer of sports cars, Ferrari utilizes a value-driven cost structure.

While it is difficult to compare exact data, manufacturing relatively bespoke vehicles by hand is more expensive than churning out thousands of the same model on a production line.

Nevertheless, estimates suggest Ferrari only makes about $6,000 in profit for each car that sells for an average price of $200,000.

Ferrari’s main costs are incurred from:

• Raw materials and parts.
• Research and development – this was the company’s most significant expense in 2016 because of expenses associated with its Formula 1 racing team.
• Labor – relatively high compared to less prestigious car brands.
• Advertising, and
• Other – which includes depreciation, overheads, markups, logistics, etc.

Wizz-Air is a Hungarian ultra-low-cost airline carrier that unsurprisingly employs a cost-driven structure to provide the most value to travelers.

Like Walmart, Wizz Air can undercut the vast majority of competition by using economies of scale.

In 2020, for example, it was offering two-hour flights for as little as $21 each way .

Wizz Air can offer these extremely low ticket prices because it chooses to collect a smaller profit from more passengers rather than earning a larger profit on fewer passengers.

This means populating each of the company’s Airbus A320s with as many seats as possible and removing business class altogether.

The aircraft themselves are also turned around as quickly as possible to ensure they spend the maximum amount of time in the air.

The company also minimizes costs with the following initiatives:

• A fleet comprised of one type of aircraft. With staff only required to be trained on one model, costs are reduced.
• Continuous leasing. This means Wizz Air has access to only the most reliable and fuel-efficient models.
• Undesirable flight times. Many of Wizz Air’s flights take off early in the morning or very late at night.
• Basic airport services. Scheduled services also operate in satellite or budget terminals that do not contain lounges or other creature comforts.

Key Highlights

• Cost Structure Overview: The cost structure of a business is a crucial aspect that defines how the company allocates resources to produce and deliver its products or services. It includes both fixed and variable costs that impact the company’s profitability.
• Revenue and Cost Relationship: Understanding how a company makes money (revenue generation) and how it spends money (cost structure) is essential for assessing its financial health and sustainability. The balance between revenue and expenses is a key determinant of profitability.
• Business Model Canvas: The Business Model Canvas, created by Alexander Osterwalder, is a popular tool used to visualize and analyze a company’s business model. It breaks down various components, including cost structure, to provide a holistic view of the business.
• Primary Cost Components: Cost structure comprises several primary cost components, such as labor, materials, overhead, marketing , research and development (R&D), and administrative expenses. These costs can vary significantly across industries and business models.
• Cost of Goods Sold (COGS): COGS represents the direct costs associated with producing or delivering a company’s products or services. It’s a critical cost component in many businesses, particularly in manufacturing and retail.
• Operational Scalability: Operational scalability is the ability of a company to handle increased demand for its offerings without incurring proportionately higher costs. Achieving operational scalability is vital for sustainable growth .
• Balancing Growth and Costs: While rapid growth is a goal for many startups, it’s important to balance growth with cost management. Uncontrolled growth can lead to financial challenges if expenses outpace revenue.
• Unit Economics: Analyzing unit economics involves examining the profitability of each unit (product or service) a company sells. Positive unit economics indicate that a company can generate profits at the unit level, contributing to overall profitability.
• Case Studies: Real-world examples of companies like Google, Netflix, Amazon, Spotify, and Apple are used to illustrate how their unique cost structures have played a critical role in shaping their business models and success.
• Platform Business Models: Some companies, like Apple, have transitioned from traditional product-centric models to platform-centric models. These platforms create ecosystems that drive additional revenue streams, such as app stores and services.
• Long-Term Strategy: Building a sustainable cost structure is essential for long-term success. Companies must ensure that their cost-to-revenue ratios allow for consistent profitability and adapt to changes in the business landscape.
• Market Dominance: Achieving dominance in a specific market, as seen with Amazon Web Services (AWS), can lead to wide profit margins and strong financial performance. Companies that can leverage their market position effectively can enjoy sustainable success.
• Industry-Specific Cost Factors: Different industries and sectors have unique cost factors that impact their cost structures. For instance, airlines like Wizz Air focus on cost optimization to offer low-cost flights to customers.
• Value-Driven and Cost-Driven Models: Businesses can adopt either a value-driven or cost-driven cost structure. Value-driven models emphasize delivering premium products or services, while cost-driven models focus on cost efficiency and affordability.
• Continuous Analysis: Companies should regularly assess their cost structures and adjust them as needed to remain competitive and adapt to changing market conditions.
• Importance of Free Services: Free or freemium services, like Spotify’s ad-supported platform, can serve as acquisition funnels to convert free users into paying customers. These free offerings have costs but contribute to overall revenue.
• Financial Metrics: Key financial metrics like gross margin, net profit margin, and return on investment (ROI) are essential for evaluating the effectiveness of a company’s cost structure.
• Strategic Decision-Making: Cost structure analysis informs strategic decisions, including resource allocation, pricing strategies, and investments in innovation and growth .
• Marketplace and Ecosystems: Building marketplaces and ecosystems, as seen with Apple’s App Store, can create additional revenue streams beyond core product sales.
• Customer Acquisition Costs: Understanding the cost of acquiring new customers is vital for assessing the efficiency of marketing and sales efforts.

Examples & Case Studies

Alternatives to the Business Model Canvas

Fourweekmba squared triangle business model.

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.

FourWeekMBA VTDF Framework For Tech Business Models

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.

A tech  business model  is made of four main components:  value   model  ( value  propositions,  mission ,  vision ), technological  model  (R&D management),  distribution   model  (sales and  marketing   organizational structure ), and financial  model  (revenue modeling, cost structure, profitability and  cash  generation/management). Those elements coming together can serve as the basis to build a solid tech business  model .

Download The VTDF Framework Template Here

FourWeekMBA Business Toolbox

Business Engineering

Asymmetric Business Models

Business Competition

Technological Modeling

Transitional Business Models

Minimum Viable Audience

Business Scaling

Market Expansion Theory

Speed-Reversibility

Asymmetric Betting

Growth Matrix

Revenue Streams Matrix

Revenue Modeling

Pricing Strategies

Additional Resources:

• Successful Types of Business Models You Need to Know
• Business Strategy: Definition, Examples, And Case Studies
• What Is a Business Model Canvas? Business Model Canvas Explained
• Blitzscaling Business Model Innovation Canvas In A Nutshell
• What Is a Value Proposition? Value Proposition Canvas Explained
• What Is a Lean Startup Canvas? Lean Startup Canvas Explained
• What Is Market Segmentation? the Ultimate Guide to Market Segmentation
• Marketing Strategy: Definition, Types, And Examples
• What Is Product-Market Fit? Product-Market Fit In A Nutshell

More Resources

About The Author

Gennaro Cuofano

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