A step variable cost is a cost that generally varies with the level of activity, but which tends to be incurred at certain discrete points and to involve large changes in amounts when such a point is reached. Conversely, a truly variable cost will vary continually and directly in concert with the level of activity.
An example of a step variable cost is the compensation of a quality assurance (QA) worker in the assembly area of a production department. Each QA worker is capable of reviewing a certain number of parts per day. Once the production process exceeds that volume level, another quality assurance worker must be hired. Thus, the cost of the QA person generally varies with the level of activity, but only changes at discrete points - when the existing QA staff can no longer handle the work load, forcing another person to be hired.
The example shows a common characteristic of a step variable cost, which is that there tends to be a relatively wide activity range within which the existing cost can be incurred without incurring any additional cost, and after which a large additional cost must be incurred. To return to the example, this means that the QA person could be more efficient or work somewhat longer hours in order to avoid incurring the large incremental cost of an additional person. In such a situation, it may be more cost-effective for the employer to offer overtime to the existing staff than to pay the more substantial cost of a new hire.
Because a step variable cost can remain approximately the same while activity levels change, this step effect can impact the allocated cost per manufactured unit. The allocated amount per unit decreases as the number of units produced increases, until such time as the higher volume level triggers the incurrence of a new step variable cost, after which the cost per unit increases due to the higher total variable cost.