What is cost structure?

Cost structure is the types and relative proportions of fixed and variable costs that a business incurs. The concept can be defined in smaller units, such as by product, service, product line, customer, division, or geographic region. Cost structure is used as a tool to determine prices, if you are using a cost-based pricing strategy, as well as to highlight areas in which costs might potentially be reduced.

To define a cost structure, you need to define every cost incurred in relation to a cost object. The following bullet points highlight key elements of the cost structures of various cost objects:

• Product cost structure
  • Fixed costs. Direct labor, manufacturing overhead
  • Variable costs. Direct materials, commissions, production supplies
• Service cost structure
  • Fixed costs. Administrative overhead
  • Variable costs. Staff wages, payroll taxes, travel and entertainment
• Product line cost structure
  • Fixed costs. Administrative overhead, manufacturing overhead, direct labor
  • Variable costs. Direct materials, commissions, production supplies
• Customer cost structure
  • Fixed costs. Administrative overhead for customer service, warranty claims
  • Variable costs. Costs of products and services sold to the customer, product returns

Some of the preceding costs can be difficult to define, so you may need to implement an activity-based costing project to more closely assign costs to the cost structure of the cost object in question.

You can alter the competitive posture of a business by altering its cost structure, not only in total, but between its fixed and variable cost components. For example, you could outsource the functions of a department to a supplier who is willing to bill the company based on usage levels. By doing so, you are eliminating a fixed cost in favor of a variable cost, which means that the company now has a lower break even point, so that it can still earn a profit at lower sales levels.

Related Topics

Activity-based costing 
Financial statement analysis 
How to calculate cost per unit 
Overhead allocation 
What is a relevant cost?