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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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(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.

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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How to Write a Business Plan: Step-by-Step Guide + Examples

Noah Parsons

24 min. read

Updated May 7, 2024

Writing a business plan doesn’t have to be complicated. 

In this step-by-step guide, you’ll learn how to write a business plan that’s detailed enough to impress bankers and potential investors, while giving you the tools to start, run, and grow a successful business.

• The basics of business planning

If you’re reading this guide, then you already know why you need a business plan . 

You understand that planning helps you: 

• Raise money
• Grow strategically
• Keep your business on the right track 

As you start to write your plan, it’s useful to zoom out and remember what a business plan is .

At its core, a business plan is an overview of the products and services you sell, and the customers that you sell to. It explains your business strategy: how you’re going to build and grow your business, what your marketing strategy is, and who your competitors are.

Most business plans also include financial forecasts for the future. These set sales goals, budget for expenses, and predict profits and cash flow. 

A good business plan is much more than just a document that you write once and forget about. It’s also a guide that helps you outline and achieve your goals. 

After completing your plan, you can use it as a management tool to track your progress toward your goals. Updating and adjusting your forecasts and budgets as you go is one of the most important steps you can take to run a healthier, smarter business. 

We’ll dive into how to use your plan later in this article.

There are many different types of plans , but we’ll go over the most common type here, which includes everything you need for an investor-ready plan. However, if you’re just starting out and are looking for something simpler—I recommend starting with a one-page business plan . It’s faster and easier to create. 

It’s also the perfect place to start if you’re just figuring out your idea, or need a simple strategic plan to use inside your business.

Dig deeper : How to write a one-page business plan

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• What to include in your business plan

Executive summary

The executive summary is an overview of your business and your plans. It comes first in your plan and is ideally just one to two pages. Most people write it last because it’s a summary of the complete business plan.

Ideally, the executive summary can act as a stand-alone document that covers the highlights of your detailed plan. 

In fact, it’s common for investors to ask only for the executive summary when evaluating your business. If they like what they see in the executive summary, they’ll often follow up with a request for a complete plan, a pitch presentation , or more in-depth financial forecasts .

Your executive summary should include:

• A summary of the problem you are solving
• A description of your product or service
• An overview of your target market
• A brief description of your team
• A summary of your financials
• Your funding requirements (if you are raising money)

Dig Deeper: How to write an effective executive summary

Products and services description

This is where you describe exactly what you’re selling, and how it solves a problem for your target market. The best way to organize this part of your plan is to start by describing the problem that exists for your customers. After that, you can describe how you plan to solve that problem with your product or service. 

This is usually called a problem and solution statement .

To truly showcase the value of your products and services, you need to craft a compelling narrative around your offerings. How will your product or service transform your customers’ lives or jobs? A strong narrative will draw in your readers.

This is also the part of the business plan to discuss any competitive advantages you may have, like specific intellectual property or patents that protect your product. If you have any initial sales, contracts, or other evidence that your product or service is likely to sell, include that information as well. It will show that your idea has traction , which can help convince readers that your plan has a high chance of success.

Market analysis

Your target market is a description of the type of people that you plan to sell to. You might even have multiple target markets, depending on your business. 

A market analysis is the part of your plan where you bring together all of the information you know about your target market. Basically, it’s a thorough description of who your customers are and why they need what you’re selling. You’ll also include information about the growth of your market and your industry .

Try to be as specific as possible when you describe your market. 

Include information such as age, income level, and location—these are what’s called “demographics.” If you can, also describe your market’s interests and habits as they relate to your business—these are “psychographics.” 

Related: Target market examples

Essentially, you want to include any knowledge you have about your customers that is relevant to how your product or service is right for them. With a solid target market, it will be easier to create a sales and marketing plan that will reach your customers. That’s because you know who they are, what they like to do, and the best ways to reach them.

Next, provide any additional information you have about your market. 

What is the size of your market ? Is the market growing or shrinking? Ideally, you’ll want to demonstrate that your market is growing over time, and also explain how your business is positioned to take advantage of any expected changes in your industry.

Dig Deeper: Learn how to write a market analysis

Competitive analysis

Part of defining your business opportunity is determining what your competitive advantage is. To do this effectively, you need to know as much about your competitors as your target customers. 

Every business has some form of competition. If you don’t think you have competitors, then explore what alternatives there are in the market for your product or service. 

For example: In the early years of cars, their main competition was horses. For social media, the early competition was reading books, watching TV, and talking on the phone.

A good competitive analysis fully lays out the competitive landscape and then explains how your business is different. Maybe your products are better made, or cheaper, or your customer service is superior. Maybe your competitive advantage is your location – a wide variety of factors can ultimately give you an advantage.

Dig Deeper: How to write a competitive analysis for your business plan

Marketing and sales plan

The marketing and sales plan covers how you will position your product or service in the market, the marketing channels and messaging you will use, and your sales tactics. 

The best place to start with a marketing plan is with a positioning statement . 

This explains how your business fits into the overall market, and how you will explain the advantages of your product or service to customers. You’ll use the information from your competitive analysis to help you with your positioning. 

For example: You might position your company as the premium, most expensive but the highest quality option in the market. Or your positioning might focus on being locally owned and that shoppers support the local economy by buying your products.

Once you understand your positioning, you’ll bring this together with the information about your target market to create your marketing strategy . 

This is how you plan to communicate your message to potential customers. Depending on who your customers are and how they purchase products like yours, you might use many different strategies, from social media advertising to creating a podcast. Your marketing plan is all about how your customers discover who you are and why they should consider your products and services. 

While your marketing plan is about reaching your customers—your sales plan will describe the actual sales process once a customer has decided that they’re interested in what you have to offer. 

If your business requires salespeople and a long sales process, describe that in this section. If your customers can “self-serve” and just make purchases quickly on your website, describe that process. 

A good sales plan picks up where your marketing plan leaves off. The marketing plan brings customers in the door and the sales plan is how you close the deal.

Together, these specific plans paint a picture of how you will connect with your target audience, and how you will turn them into paying customers.

Dig deeper: What to include in your sales and marketing plan

Business operations

The operations section describes the necessary requirements for your business to run smoothly. It’s where you talk about how your business works and what day-to-day operations look like. 

Depending on how your business is structured, your operations plan may include elements of the business like:

• Supply chain management
• Manufacturing processes
• Equipment and technology
• Distribution

Some businesses distribute their products and reach their customers through large retailers like Amazon.com, Walmart, Target, and grocery store chains. 

These businesses should review how this part of their business works. The plan should discuss the logistics and costs of getting products onto store shelves and any potential hurdles the business may have to overcome.

If your business is much simpler than this, that’s OK. This section of your business plan can be either extremely short or more detailed, depending on the type of business you are building.

For businesses selling services, such as physical therapy or online software, you can use this section to describe the technology you’ll leverage, what goes into your service, and who you will partner with to deliver your services.

Dig Deeper: Learn how to write the operations chapter of your plan

Key milestones and metrics

Although it’s not required to complete your business plan, mapping out key business milestones and the metrics can be incredibly useful for measuring your success.

Good milestones clearly lay out the parameters of the task and set expectations for their execution. You’ll want to include:

• A description of each task
• The proposed due date
• Who is responsible for each task

If you have a budget, you can include projected costs to hit each milestone. You don’t need extensive project planning in this section—just list key milestones you want to hit and when you plan to hit them. This is your overall business roadmap. 

Possible milestones might be:

• Website launch date
• Store or office opening date
• First significant sales
• Break even date
• Business licenses and approvals

You should also discuss the key numbers you will track to determine your success. Some common metrics worth tracking include:

• Conversion rates
• Customer acquisition costs
• Profit per customer
• Repeat purchases

It’s perfectly fine to start with just a few metrics and grow the number you are tracking over time. You also may find that some metrics simply aren’t relevant to your business and can narrow down what you’re tracking.

Dig Deeper: How to use milestones in your business plan

Organization and management team

Investors don’t just look for great ideas—they want to find great teams. Use this chapter to describe your current team and who you need to hire . You should also provide a quick overview of your location and history if you’re already up and running.

Briefly highlight the relevant experiences of each key team member in the company. It’s important to make the case for why yours is the right team to turn an idea into a reality. 

Do they have the right industry experience and background? Have members of the team had entrepreneurial successes before? 

If you still need to hire key team members, that’s OK. Just note those gaps in this section.

Your company overview should also include a summary of your company’s current business structure . The most common business structures include:

• Sole proprietor
• Partnership

Be sure to provide an overview of how the business is owned as well. Does each business partner own an equal portion of the business? How is ownership divided? 

Potential lenders and investors will want to know the structure of the business before they will consider a loan or investment.

Dig Deeper: How to write about your company structure and team

Financial plan

Last, but certainly not least, is your financial plan chapter. 

Entrepreneurs often find this section the most daunting. But, business financials for most startups are less complicated than you think, and a business degree is certainly not required to build a solid financial forecast. 

A typical financial forecast in a business plan includes the following:

• Sales forecast : An estimate of the sales expected over a given period. You’ll break down your forecast into the key revenue streams that you expect to have.
• Expense budget : Your planned spending such as personnel costs , marketing expenses, and taxes.
• Profit & Loss : Brings together your sales and expenses and helps you calculate planned profits.
• Cash Flow : Shows how cash moves into and out of your business. It can predict how much cash you’ll have on hand at any given point in the future.
• Balance Sheet : A list of the assets, liabilities, and equity in your company. In short, it provides an overview of the financial health of your business. 

A strong business plan will include a description of assumptions about the future, and potential risks that could impact the financial plan. Including those will be especially important if you’re writing a business plan to pursue a loan or other investment.

Dig Deeper: How to create financial forecasts and budgets

This is the place for additional data, charts, or other information that supports your plan.

Including an appendix can significantly enhance the credibility of your plan by showing readers that you’ve thoroughly considered the details of your business idea, and are backing your ideas up with solid data.

Just remember that the information in the appendix is meant to be supplementary. Your business plan should stand on its own, even if the reader skips this section.

Dig Deeper : What to include in your business plan appendix

Optional: Business plan cover page

Adding a business plan cover page can make your plan, and by extension your business, seem more professional in the eyes of potential investors, lenders, and partners. It serves as the introduction to your document and provides necessary contact information for stakeholders to reference.

Your cover page should be simple and include:

• Company logo
• Business name
• Value proposition (optional)
• Business plan title
• Completion and/or update date
• Address and contact information
• Confidentiality statement

Just remember, the cover page is optional. If you decide to include it, keep it very simple and only spend a short amount of time putting it together.

Dig Deeper: How to create a business plan cover page

How to use AI to help write your business plan

Generative AI tools such as ChatGPT can speed up the business plan writing process and help you think through concepts like market segmentation and competition. These tools are especially useful for taking ideas that you provide and converting them into polished text for your business plan.

The best way to use AI for your business plan is to leverage it as a collaborator , not a replacement for human creative thinking and ingenuity. 

AI can come up with lots of ideas and act as a brainstorming partner. It’s up to you to filter through those ideas and figure out which ones are realistic enough to resonate with your customers. 

There are pros and cons of using AI to help with your business plan . So, spend some time understanding how it can be most helpful before just outsourcing the job to AI.

Learn more: 10 AI prompts you need to write a business plan

• Writing tips and strategies

To help streamline the business plan writing process, here are a few tips and key questions to answer to make sure you get the most out of your plan and avoid common mistakes .  

Determine why you are writing a business plan

Knowing why you are writing a business plan will determine your approach to your planning project. 

For example: If you are writing a business plan for yourself, or just to use inside your own business , you can probably skip the section about your team and organizational structure. 

If you’re raising money, you’ll want to spend more time explaining why you’re looking to raise the funds and exactly how you will use them.

Regardless of how you intend to use your business plan , think about why you are writing and what you’re trying to get out of the process before you begin.

Keep things concise

Probably the most important tip is to keep your business plan short and simple. There are no prizes for long business plans . The longer your plan is, the less likely people are to read it. 

So focus on trimming things down to the essentials your readers need to know. Skip the extended, wordy descriptions and instead focus on creating a plan that is easy to read —using bullets and short sentences whenever possible.

Have someone review your business plan

Writing a business plan in a vacuum is never a good idea. Sometimes it’s helpful to zoom out and check if your plan makes sense to someone else. You also want to make sure that it’s easy to read and understand.

Don’t wait until your plan is “done” to get a second look. Start sharing your plan early, and find out from readers what questions your plan leaves unanswered. This early review cycle will help you spot shortcomings in your plan and address them quickly, rather than finding out about them right before you present your plan to a lender or investor.

If you need a more detailed review, you may want to explore hiring a professional plan writer to thoroughly examine it.

Use a free business plan template and business plan examples to get started

Knowing what information to include in a business plan is sometimes not quite enough. If you’re struggling to get started or need additional guidance, it may be worth using a business plan template. 

There are plenty of great options available (we’ve rounded up our 8 favorites to streamline your search).

But, if you’re looking for a free downloadable business plan template , you can get one right now; download the template used by more than 1 million businesses. 

Or, if you just want to see what a completed business plan looks like, check out our library of over 550 free business plan examples . 

We even have a growing list of industry business planning guides with tips for what to focus on depending on your business type.

Common pitfalls and how to avoid them

It’s easy to make mistakes when you’re writing your business plan. Some entrepreneurs get sucked into the writing and research process, and don’t focus enough on actually getting their business started. 

Here are a few common mistakes and how to avoid them:

Not talking to your customers : This is one of the most common mistakes. It’s easy to assume that your product or service is something that people want. Before you invest too much in your business and too much in the planning process, make sure you talk to your prospective customers and have a good understanding of their needs.

• Overly optimistic sales and profit forecasts: By nature, entrepreneurs are optimistic about the future. But it’s good to temper that optimism a little when you’re planning, and make sure your forecasts are grounded in reality. 
• Spending too much time planning: Yes, planning is crucial. But you also need to get out and talk to customers, build prototypes of your product and figure out if there’s a market for your idea. Make sure to balance planning with building.
• Not revising the plan: Planning is useful, but nothing ever goes exactly as planned. As you learn more about what’s working and what’s not—revise your plan, your budgets, and your revenue forecast. Doing so will provide a more realistic picture of where your business is going, and what your financial needs will be moving forward.
• Not using the plan to manage your business: A good business plan is a management tool. Don’t just write it and put it on the shelf to collect dust – use it to track your progress and help you reach your goals.
• Presenting your business plan

The planning process forces you to think through every aspect of your business and answer questions that you may not have thought of. That’s the real benefit of writing a business plan – the knowledge you gain about your business that you may not have been able to discover otherwise.

With all of this knowledge, you’re well prepared to convert your business plan into a pitch presentation to present your ideas. 

A pitch presentation is a summary of your plan, just hitting the highlights and key points. It’s the best way to present your business plan to investors and team members.

Dig Deeper: Learn what key slides should be included in your pitch deck

Use your business plan to manage your business

One of the biggest benefits of planning is that it gives you a tool to manage your business better. With a revenue forecast, expense budget, and projected cash flow, you know your targets and where you are headed.

And yet, nothing ever goes exactly as planned – it’s the nature of business.

That’s where using your plan as a management tool comes in. The key to leveraging it for your business is to review it periodically and compare your forecasts and projections to your actual results.

Start by setting up a regular time to review the plan – a monthly review is a good starting point. During this review, answer questions like:

• Did you meet your sales goals?
• Is spending following your budget?
• Has anything gone differently than what you expected?

Now that you see whether you’re meeting your goals or are off track, you can make adjustments and set new targets. 

Maybe you’re exceeding your sales goals and should set new, more aggressive goals. In that case, maybe you should also explore more spending or hiring more employees. 

Or maybe expenses are rising faster than you projected. If that’s the case, you would need to look at where you can cut costs.

A plan, and a method for comparing your plan to your actual results , is the tool you need to steer your business toward success.

Learn More: How to run a regular plan review

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How to write a business plan FAQ

What is a business plan?

A document that describes your business , the products and services you sell, and the customers that you sell to. It explains your business strategy, how you’re going to build and grow your business, what your marketing strategy is, and who your competitors are.

What are the benefits of a business plan?

A business plan helps you understand where you want to go with your business and what it will take to get there. It reduces your overall risk, helps you uncover your business’s potential, attracts investors, and identifies areas for growth.

Having a business plan ultimately makes you more confident as a business owner and more likely to succeed for a longer period of time.

What are the 7 steps of a business plan?

The seven steps to writing a business plan include:

• Write a brief executive summary
• Describe your products and services.
• Conduct market research and compile data into a cohesive market analysis.
• Describe your marketing and sales strategy.
• Outline your organizational structure and management team.
• Develop financial projections for sales, revenue, and cash flow.
• Add any additional documents to your appendix.

What are the 5 most common business plan mistakes?

There are plenty of mistakes that can be made when writing a business plan. However, these are the 5 most common that you should do your best to avoid:

• 1. Not taking the planning process seriously.
• Having unrealistic financial projections or incomplete financial information.
• Inconsistent information or simple mistakes.
• Failing to establish a sound business model.
• Not having a defined purpose for your business plan.

What questions should be answered in a business plan?

Writing a business plan is all about asking yourself questions about your business and being able to answer them through the planning process. You’ll likely be asking dozens and dozens of questions for each section of your plan.

However, these are the key questions you should ask and answer with your business plan:

• How will your business make money?
• Is there a need for your product or service?
• Who are your customers?
• How are you different from the competition?
• How will you reach your customers?
• How will you measure success?

How long should a business plan be?

The length of your business plan fully depends on what you intend to do with it. From the SBA and traditional lender point of view, a business plan needs to be whatever length necessary to fully explain your business. This means that you prove the viability of your business, show that you understand the market, and have a detailed strategy in place.

If you intend to use your business plan for internal management purposes, you don’t necessarily need a full 25-50 page business plan. Instead, you can start with a one-page plan to get all of the necessary information in place.

What are the different types of business plans?

While all business plans cover similar categories, the style and function fully depend on how you intend to use your plan. Here are a few common business plan types worth considering.

Traditional business plan: The tried-and-true traditional business plan is a formal document meant to be used when applying for funding or pitching to investors. This type of business plan follows the outline above and can be anywhere from 10-50 pages depending on the amount of detail included, the complexity of your business, and what you include in your appendix.

Business model canvas: The business model canvas is a one-page template designed to demystify the business planning process. It removes the need for a traditional, copy-heavy business plan, in favor of a single-page outline that can help you and outside parties better explore your business idea.

One-page business plan: This format is a simplified version of the traditional plan that focuses on the core aspects of your business. You’ll typically stick with bullet points and single sentences. It’s most useful for those exploring ideas, needing to validate their business model, or who need an internal plan to help them run and manage their business.

Lean Plan: The Lean Plan is less of a specific document type and more of a methodology. It takes the simplicity and styling of the one-page business plan and turns it into a process for you to continuously plan, test, review, refine, and take action based on performance. It’s faster, keeps your plan concise, and ensures that your plan is always up-to-date.

What’s the difference between a business plan and a strategic plan?

A business plan covers the “who” and “what” of your business. It explains what your business is doing right now and how it functions. The strategic plan explores long-term goals and explains “how” the business will get there. It encourages you to look more intently toward the future and how you will achieve your vision.

However, when approached correctly, your business plan can actually function as a strategic plan as well. If kept lean, you can define your business, outline strategic steps, and track ongoing operations all with a single plan.

See why 1.2 million entrepreneurs have written their business plans with LivePlan

Noah is the COO at Palo Alto Software, makers of the online business plan app LivePlan. He started his career at Yahoo! and then helped start the user review site Epinions.com. From there he started a software distribution business in the UK before coming to Palo Alto Software to run the marketing and product teams.

Table of Contents

• Use AI to help write your plan
• Common planning mistakes
• Manage with your business plan
• Templates and examples

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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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Plan Projections

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Home > Financial Projections > Cost Structure in a Business Plan

Cost Structure in a Business Plan

What is cost structure.

Financial projections need to take account of the cost structure of a business. Cost structure simply refers to the split between variable costs and fixed costs, but can have a significant impact on whether a new start up business is successful or not.

Fixed and Variable Costs

First a few definitions. A variable cost is a cost which changes in direct proportion to any production or selling activity, examples include, direct materials and labor used in manufacture, product cost, and sales commissions. On the other hand, a fixed cost is a cost which will occur whether or not a business has any production or selling activity. Fixed costs are a function of the passage of time, examples include rent, salaries, and insurance.

Low Fixed Cost Structure or High Fixed Cost Structure?

Although the cost structure of a business is to some extent fixed by the nature of the business and the type of industry in which it operates, decisions can be taken to directly influence the split between fixed and variable costs. It is important to understand that a business can have the same sales, total costs and therefore profit, but a completely different costs structure, as seen in the diagrams below.

Both businesses have the same sales, total costs, and profit, however, the first business has a high fixed cost structure compared to the low fixed cost structure of the second business.

Business Plan Cost Structure and Break Even

Consider as an example the two start up businesses shown in the table below. The financial projections of the first business show a high fixed cost structure. the business plans to start by investing heavily in production facilities, machinery and equipment to manufacture and distribute its own product. The consequence of this decision is high fixed costs but lower variable costs.

The second business proposes a lean start up. It plans to have the manufacture and distribution outsourced to a third party, its needs smaller premises and less investment in machinery and equipment and therefore has lower fixed costs but correspondingly higher variable costs, as payments need to be made to the third parties for manufacture and distribution.

Effect of Cost Structure on Break Even Calculations

In each case, the number of units sold (6,000), selling price (12,00), total costs (65,000), and profits (7,000) are identical. Using this information and the break even formula, the break even point can be calculated for each of the start up businesses.

The break even formula is:

and the break even units are given by the formula:

The results of the calculations using the formulas are summarized in the table below.

We can see that even though everything else is the same, the financial structure of the business has resulted in a completely different break even position.

For the low fixed cost structure business, only 3,083 units need to be sold at 12.00 to reach break even as shown in the diagram below.

In contrast for the high fixed cost business 5,028 units need to be sold to reach break even as indicated in the diagram below.

In order to break even, the high fixed cost business needs to sell 1,945 (63%) more units than the low fixed cost business.

The conclusion is that when producing financial projections for a start up business, in order to reduce the break even point to an acceptable level, the cost structure should aim to keep the fixed costs as low as possible.

About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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What is the Cost Structure in a Business Plan?

By: Author Tony Martins Ajaero

Home » Business Plans

Cost structure in a business plan refers to a section in the business plan where all the necessary costs or expenses expected to be incurred to attain the desired objective noted in the business plan are explicitly outlined.

Depending on the objective of the business plan, these costs may include the cost of purchasing the raw material, the cost of marketing, or even the cost of packaging the finished products. Note that starting or running a business will involve some kind of cost, and this is what is noted in the cost structure of the business plan.

It is imperative to note that cost structures differ between retailers and service providers, therefore the expense accounts noted in a business plan will depend on the cost objects, such as a product, service, project, customer, or business activity.

Even within a company, note that cost structure may vary between product lines, divisions, or business units, owing to the varying types of activities they perform. Howbeit, the primary components of any cost structure are variable and fixed costs.

Variable costs refer to costs that alter in direct proportion to production/selling activities. These costs may include sales commissions, product costs, cost of labor and raw materials used in manufacturing, etc. Fixed costs refer to those that stay the same regardless of the volume of sales or business activity.

They are costs that accumulate owing to the passage of time such as insurance, salaries, and rent. A good number of individuals believe that as long as a business makes the same amount of profit as another business with similar operations, the cost structure they leverage makes no difference.

However, an analysis of what occurs to a business’ break-even point when there are alterations to its cost structure reveals the difference. Therefore, when making financial projections for a new business, it is advisable you keep the fixed costs at the barest minimum so that the break-even point can be reached much sooner.

How to Write the Cost Structure in a Business Plan

To ensure you can maximize the profits of your business, it is imperative you understand all the costs associated with starting and running your business, and also seek ways to reduce them to the minimum. Below is a detailed guideline on how to write the cost structure section of your business plan.

Make a Summary of Your Costs and Expenditure

While you will most often note your costs in your financial tables, it is recommended you give a summary of your main costs and timescales for expenditure. This will help buttress how your business will function within the next few years. To do this, take your time to analyze all attributed ‘fixed’ costs and ‘variable’ costs as they can help plan your cash flow.

• Fixed costs : These are the regular or one-off payments that have been concluded in advance, for example, rent, insurance, and subscriptions. You can review these annually to validate that you’re getting a good deal.
• Variable costs : Note that these are predictable costs that can change owing to your business activity and volume of sales. For businesses selling products, variable costs might include direct materials, commissions, and piece-rate wages. For service providers, variable expenses are composed of wages, bonuses, and travel costs.

While making a summary of your cost and expenses, it is recommended you show that your costs align with your activity – costs will most likely increase as your activity increases or as your sales volume goes up. Also note that you may have to employ more staff, move to a larger business facility or obtain more supplies.

Also note that things like insurance will be more costly as you employ more staff and more customers, therefore take heed that it is reflected in your cost summary and your cash flow.

Make a Concise Description of Your Main Sources of Income

The next step will be to declare whether you have secured the income (for instance, a grant or contract that has already been concluded) or if it is an income forecast (for instance, sales of your new product or service).

If you intend to depend on one source, then you must note any plans you have to diversify your income or what you intend to do if you lose that income source. If you have or are applying for loans or social investment, make sure you describe in clear detail your plans for repayment.

Describe Your Pricing Strategy

Depending on the type of business or your objective for putting together the business plan, consider using this section to note your pricing strategy. Have in mind there are numerous ways to set a price for your product or service.

• Mark up : Understand the price the product or service costs you, then add a percentage to get the final price (e.g. cost + 10%).
• Going rate : Take your time to research the competition to understand what a typical price is and try to match it.
• Market-oriented : Set the price based on research with your target market and what is obtainable in your market.
• Perceived value : Consider the value the consumer places on a product. Note that this may be more than the product is actually worth. For instance, people are known to pay more for branded goods even though the product is more or less the same as a non-branded item because they perceive it to be better or higher quality.
• Pricing schemes : You may also choose to make available discounts for certain groups, or for early-bird payment, bulk purchases, or off-peak use.

It is important to note that expensive items are seen to be more valuable, and a good number of voluntary organizations underestimate the value of their work. Any successful business activity will have to give a surplus between the price and the cost, and your costs may be higher than what is common in the market. Also, take your time to work out how much it costs to deliver your product or service before you set your price.

The cost structure is mostly attributed to all the costs that can be incurred while working on the goal of the business plan. Always remember that the aim of a cost structure in your business plan is to note the funds you need during the business process or for the business as a whole. It is primarily to allocate the costs in such a way that the costs would be minimized and the profits earned effectively maximized.

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Home Blog Business What is Cost Structure in a Business Model and Why Does it Matter

What is Cost Structure in a Business Model and Why Does it Matter

Imagine running a charming little bakeshop. While it paints a delightful picture, the reality is that running a business, even as sweet as a bakeshop, entails numerous costs. From procuring quality ingredients for your delectable creations to acquiring resources to showcase and sell them, every step incurs expenses.

Businesses need financial clarity to determine these expenses and position themselves for success in a competitive landscape. This clarity is achieved through a comprehensive understanding of their Cost Structure.

Table of Contents

• What is Cost Structure

Types / Characteristics of Costs

How to analyze cost structure, cost structure optimization strategies, case study: netflix, what is cost structure.

Alexander Osterwalder and Yves Pigneur provide a short and straightforward description of what a Cost Structure is in their book entitled Business Model Generation :

“The Cost Structure describes the most important costs incurred while operating under a particular business model.”

Cost Structure is part of the Business Model Canvas – also developed by Alexander Osterwalder – which comprises nine building blocks showing the logic of how a company intends to deliver value and make money. Within the cost structure block, entrepreneurs pinpoint the most significant expenses in their operations, precisely dissecting each cost.

We can easily ask ourselves these questions before approaching the Cost Structure:

• What are our fixed and variable costs?
• What are the most significant expenses in our operations?
• How much do we need to make to earn a profit?

While it entails the costs required to manufacture products or provide services, it goes beyond that, encompassing resources spent on other vital blocks of the business model, like maintaining customer relationships and channels.

Why is it important to come up with a cost structure? There are rippling benefits to undergoing this activity – setting appropriate prices, identifying revenue streams, reducing expenses, and more. We will discuss them in detail further down this article.

The types of costs can be classified based on their behavior concerning changes in the activity level or production volume, namely fixed and variable costs. Classifying your costs into fixed or variable is the first step of Costs Structure analysis.

Fixed Costs 

Fixed costs are the expenses that remain constant within a relevant range of activity or production volume. Regardless of whether the company produces more or less, fixed costs stay relatively stable. Examples of fixed costs are rent, manufacturing facilities, and property taxes.

Variable Costs

Variable costs are the expenses that fluctuate directly to changes in the activity level or production volume. As the company produces more product units or provides more services, variable costs increase, and vice versa. Examples of variable costs include the “Cost of Goods Sold” or the direct costs of making a product, like raw materials, sales commissions , and labor costs for hourly workers.

The behavior of costs can vary depending on the nature of the business and its operations. A cost that may be fixed for one type of business can be variable for another kind of business.

For example, for a small office-based business, utilities like electricity and water may have relatively fixed costs. The consumption levels may not vary significantly, leading to relatively stable utility expenses. However, utilities can be considered variable costs for a manufacturing plant or facility with variable production levels. As production increases, energy consumption and utility expenses will also increase.

Thus, every business must distinguish various costs as fixed or variable to rationalize expenses.

Analyzing your company’s fixed and variable costs is fundamental in identifying effective cost-cutting strategies. Within this analysis, two distinct concepts come into play: Economies of Scope and Economies of Scale. Both of these concepts offer valuable perspectives on how to reduce costs effectively.

Economies of Scope

Economies of scope concentrate on the average cost of producing diverse goods or services within your company. It explores the cost advantages of producing multiple products or offering various services rather than producing each individually.

Economies of scope are particularly valuable when a business can efficiently diversify its offerings while leveraging fixed resources. By integrating certain activities, the company can reduce duplication of resources and streamline operations, resulting in cost savings.

Using airline companies as examples is a simple way to illustrate this concept.

Airlines that offer economy and business class can benefit from economies of scope by using the same aircraft. Rather than having separate planes for each class, the airline can optimize the use of its fleet, reducing the fixed costs associated with maintaining and operating multiple aircraft.

On top of that, offering business class provides an additional revenue stream that can help offset the cost of providing lower-priced economy-class tickets. It will also improve the likelihood of achieving higher load factors on flights, thereby spreading fixed costs over more passengers.

Economies of Scale

Economies of scale focus on the cost advantage gained from increasing the production level of a single product or service. As production volume rises, the average cost per unit decreases. This cost reduction occurs due to spreading fixed costs over a larger number of units, improved bargaining power with suppliers, and increased efficiency in production processes.

To illustrate the potential profit improvement from economies of scale, consider a phone manufacturing company that wants to purchase processors. Initially, the supplier offers 1000 processor units at a total cost of $50,000, which translates to $50 per unit. However, the supplier offers a discounted price of $75,000 if the phone manufacturer decides to purchase 2,000 units of the processor. At this volume, the per-unit price decreases to $37.5.

The potential profit improvement from economies of scale in this scenario is evident. The phone manufacturing company can reduce production costs by taking advantage of the discounted price, leading to higher profit margins for each phone manufactured.

Businesses should exercise caution and consider various factors before increasing production. Pursuing economies of scale without a thorough analysis of market demand can lead to overcapacity and potential losses if products go unsold. This brings us to the break-even analysis tool.

Break-even Analysis

Break-even analysis is a financial tool that determines the level of sales needed to cover all fixed and variable costs without making a profit or incurring a loss. To calculate the break-even point, you must know the contribution margin (selling price per unit and the variable cost per unit) and the total fixed costs.

The formula to calculate the break-even point in units is:

Break-even Point = Total Fixed Costs / Contribution Margin per Unit

Let’s return to our mobile phone manufacturing company to illustrate a break-even analysis.

Suppose the mobile phone manufacturing company has the following information:

• Selling price per unit: $599
• Variable cost per unit: $265
• Total fixed costs: $100,000

Now, let’s calculate the contribution margin per unit:

Contribution Margin per Unit = Selling Price per Unit – Variable Cost per Unit

Contribution Margin per Unit = $599 – $265 = $334

Next, we can calculate the break-even point in units using the formula:

Break-even Point (in units) = Total Fixed Costs / Contribution Margin per Unit

Break-even Point (in units) = $100,000 / $334

Break-even Point (in units) = 299.40

Since you cannot sell a fraction of a phone, we round up the break-even point to the nearest whole number. Therefore, the company needs to sell 300 mobile phones (or $179,700) to cover all its fixed costs and reach the break-even point, where it neither makes a profit nor incurs a loss.

The company can present the break-even graphically to clearly understand the relationship between costs, sales volume, and profitability. It helps stakeholders, including management and investors, grasp the break-even point and profit regions more intuitively.

Once the break-even analysis indicates that the company needs to sell a certain number of units to cover all its costs, it needs to evaluate whether it can sell that number of units and whether there is sufficient demand in the market.

1. Identifying Cost Drivers

AccounTools.com defines cost drivers as the factors that trigger a change in the cost of an activity. Cost drivers follow a cause-effect relationship, meaning they significantly impact the costs incurred by an activity or process. They can vary depending on the nature of the business and the specific activities or processes involved.

For example, in a manufacturing company, raw materials usage, machine hours, and work hours are the cost drivers as they directly impact the expenses that go into the manufacturing costs. Identifying these drivers allows businesses to optimize costs in specific areas to maximize efficiency and profitability.

If raw materials are significant cost drivers, the company can seek partnerships with suppliers to achieve economies of scale and reduce cost per unit. They may also outsource certain components or stages of the manufacturing process to reduce labor costs and machinery usage.

2. Eliminating Waste and Inefficiencies

Colloraly to the previous point, accounting for what drives up your operations cost will allow you to identify wastes and efficiencies in your processes and make rational decisions to eliminate them.

Going back to the manufacturing company example, if labor costs are pulling down the profit margin, investing in process automation may be the solution to optimize production efficiency. It will initially incur expenses, but automated processes can reduce labor hours and decrease the overall time required for production, thereby cutting costs in the long run.

3. Pricing Strategy Based on Cost Structure Optimization

Cost structure optimization is pivotal in shaping an effective pricing strategy that ensures a business remains competitive while safeguarding its financial health. That’s the whole point of conducting cost structure analysis. You want to ensure that you minimize cost, increase profitability, and, if needed, reduce consumer prices.

You can explore several pricing strategies based on the nature of your business.

• Cost-Plus Pricing – Pricing based on the total cost of producing a product or providing a service and adding a predetermined profit margin
• Value-based pricing – Pricing based on the customer’s willingness to pay (WTP) price and total production cost
• Dynamic Pricing – Pricing based on market conditions like demand and inventory levels
• Price Discrimination – Pricing that changes based on customer segments.
• Competitive Pricing – Pricing based on how rival businesses price their products or services
• Feature Dependent Pricing – Pricing based on the quality or number of features of the product purchased

Let’s explore how Netflix employs cost structure optimization to tailor its profitability and customer satisfaction pricing strategy.

Content licensing and production costs form a significant portion of their expenses (amounting to $21.83 billion in 2022) as they constantly strive to offer subscribers a diverse and engaging content library. On top of these, they also maintain technology infrastructure like data centers for streaming content. These comprise their fixed and variable costs.

To cover these costs, Netflix offers subscription plans targeting several customer segments with different preferences and budgets. It uses a mix of value-based pricing, price discrimination, and feature-dependent pricing.

In certain countries, like the U.S. and Canada, Netflix offers an ad-supported plan to entice consumers who want a cheaper alternative to the ad-free experience. This opens up another revenue stream for the company through ad placement fees from the advertisers.

In other developing countries, like the Philippines and India, Netflix has Netflix Mobile – a cheaper streaming service for phones or tablets void of advanced features like HD video quality and simultaneous streaming on multiple devices. By offering more cost-effective plans with specific limitations, Netflix can penetrate these markets and expand its global reach.

For their more expensive subscription tier, Netflix provides premium capabilities like adding extra members outside a household, full HD streaming, and spatial audio. These elements are critical for upselling users on cheaper options.

Cost Structure Analysis is an unskippable step of business planning. By analyzing fixed and variable costs, businesses can identify cost-cutting strategies, set appropriate prices, and maximize efficiency. Whether running a simple bakeshop or a company as big as Netflix, your cost structure will guide your businesses toward sustainable growth.

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Learning Outcomes

• Compare and contrast sample cost structures for company strengths and weaknesses

Your boss just stopped in your office with a flyer for a new piece of equipment that promises to replace ten of your manufacturing employees at a fraction of the cost you are paying now for labor. He is pretty excited about this opportunity and wants you to make the call and get it on order right away! You are hesitant for a few reasons, but the biggest is the huge price tag of $500,000! You need to do some analysis and put together a proposal for your boss showing the pros and cons of this big purchase, along with the effects it may have on your employees. This would be a shift from variable costs, those of the employees and the related costs, to a machine that has only one use. How are you going to prepare this proposal? Let’s first define cost structure and then look at some ideas and options.

How do we define cost structure? The percentage of sales that is related to fixed costs or variable costs is a component of cost structure. Let’s take a look at cost structure defined.

A YouTube element has been excluded from this version of the text. You can view it online here: http://pb.libretexts.org/afm-2/?p=358

Cost structure refers to the proportion of fixed and variable costs within an organization. Managers may have some control over the proportion based on responsibilities. An example might be an investment in automated equipment that saves variable labor costs. This shifts the cost from a variable cost (labor for production) to a fixed cost (purchase and depreciation of equipment).

Let’s look at how a shift from labor to equipment may look.

Currently, an employee on your manufacturing floor can produce 800 items in a standard 8 hour shift. If your employee costs $25 an hour, then the variable labor cost per item is 25 cents. What if the automated equipment that costs $500,000 can produce 100 items per hour, and has a 10 year life? It can also operate 365 days per year, does not require paid time off, sick leave or insurance, and probably doesn’t complain about working conditions!

In 10 years, this piece of equipment can make 8,760,000 items. You think you are pretty smart because now the cost per item looks like 5.7 cents per item, rather than the 25 cents per item that your employee would cost. Oh, and your employee would probably want some wage increases over that time period as well. Essentially, the way you look at it, this machine will replace roughly 5 employees, and save a ton of money in the long run.

What flaws can you see in your plan? Well, one is a shift from the labor which is a variable expense (you can send your employee home if you aren’t busy), to a fixed cost (the machine is there, and will cost $50,000 a year, whether you make 1 item or 8,760,000 items).

Here are some things to consider as you contemplate a change in cost structure of this type:

• Will this machine be able to make a different item if the item it is designed to make becomes obsolete?
• What is the resale value of this machine if we determine we no longer need it?
• What is the maximum sales we can expect for this item? Just because the machine can make almost 9 million units, doesn’t mean we can sell that many!

Whether to invest in the expensive machine to make your item, or to keep paying the labor costs depend on many factors. Without having a crystal ball, it can be hard to make these decisions. As a manager, it is your job to look at various options and make the best decision for your company.

Practice Questions

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• Cost Structures. Authored by : Freedom Learning Group. Provided by : Lumen Learning. License : CC BY: Attribution
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What Is the Cost Structure in the Business Model Canvas and How to Use It

The cost structure may be in the final steps of the business model canvas, but it is not of lesser importance.

Costs constantly incur inside a business no matter the business model it follows.

In fact, some business models are more cost-driven than others focusing on keeping their low-cost structure to a minimum. For instance, low cost airlines keep their prices low to attract more customers and increase their bookings.

Cost minimization is what most companies strive to be profitable. However, this does not apply to all businesses.

There are also those less concerned with keeping a low cost structure, focusing instead on value creation. Typical examples are luxury hotels with lavish facilities and personalized services. Their target group may be limited but, at the same time, more willing to spend extra.

Are you in the process of creating your own business and are thinking of using the business model canvas to start with?

Let’s walk through the business model canvas to learn the basics with a focus on the cost structure part of your business plan.

What is the business model canvas?

A business model canvas is essentially the blueprint of your company. It outlines your operations, your customers, or what your cost structure is together with all other strategic actions.

The business model canvas was a proposition of the consultant and entrepreneur Alexander Osterwalder and is one of the most widely used canvases for developing new business models.

What are the building blocks of the business model canvas?

The business model canvas is comprised of nine main elements:

• Key Partners : These are the strategic alliances your company forms together with other businesses or individuals.
• Key Activities : The essential activities for your business operation.
• Key Resources : The assets that your business needs to run your business and fulfil its value proposition.
• Value proposition : This is your company’s purpose of existence in meeting your client’s needs.
• Customer Relationships : How your business will interact with your customers and the kind of services it will provide to them.
• Channels : The different avenues through which your company will deliver your products, services, or value proposition to your customers.
• Customer Segments : Your customers divided into different groups or segments.
• Cost structure : The amount of money your business spends on operations, your main costs, and how cost-driven are you.
• Revenue Streams : The sources of your cash flows.

What is the cost structure in the business model canvas?

Businesses spend resources to create value. Thus, the cost structure details how a company spends these resources in all components of its business model.

Typically, they can be variable or fixed costs.

Cost structure attributes

Fixed costs : They are costs that a company has to pay each month that do not change based on the goods and services produced or sales of goods. These costs are indirect and, in a way, unavoidable. Some typical fixed costs are rent and salaries.  

Variable costs : On the other hand, variable costs are business expenses that vary depending on the intensity of business operations. For example, during high production and increased sales, the variable costs increase as there is a higher need for raw materials.

Economies of scale: As companies grow, they may have additional cost benefits. For instance, large businesses can achieve better prices when buying in bulk compared to smaller ones. As outputs increase, the average cost per unit drops.

Economies of scope: With a greater scope of activities, costs may reduce further. In particular, larger organizations can simultaneously support several goods and services with the same marketing or distribution channels.

Having a better idea of what the business model canvas entails, you should be better off in creating your own business plan. Above all, you received key information for the cost structure building block of the business model canvas.

With this knowledge, you can have a good understanding of the existing cost structure types and how you can play around with the various cost structure attributes to reduce your costs and increase your profitability.

Do you want to become an entrepreneur and learn how to use the canvas business model?

The EYES project will upskill the next European social entrepreneurs based on the EntreComp model. Further, it will teach how to apply the canvas business model to create a social business in support of the SDGs.

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Learn from the business planning experts, resources to help you get ahead, cost structure, table of contents.

Cost Structure refers to the composition and classification of costs involved in running a business. It is an integral part of a company’s business model and financial planning, detailing the various expenses incurred during business operations.

A company’s cost structure categorizes costs as fixed, variable, semi-variable, direct, and indirect, each impacting its financial health and pricing strategies.

Components of Cost Structure

• Fixed Costs : Expenses that remain constant regardless of the level of production or sales. Examples include rent, insurance premiums, and salaries of permanent staff.
• Variable Costs : Costs that vary in proportion to business activity levels. This includes the cost of goods sold (COGS), shipping fees, and sales commissions.
• Semi-Variable Costs : Expenses containing both fixed and variable components, such as utilities or wages for hourly workers.
• Direct Costs : Costs directly associated with the production of goods or services, like raw materials and direct labor.
• Indirect Costs : Expenses not directly linked to production but essential for general operations, including administrative and marketing costs.

Strategic Consideration for Startups

Startups must carefully examine their cost structure to identify potential cost savings that do not compromise product quality or customer experience, while still ensuring that prices cover costs and contribute to profitability.

Adaptation and Efficiency

As a startup grows, its cost structure may evolve, necessitating regular reviews and adjustments to maintain efficiency. For example, implementing cost control measures, embracing automation, and renegotiating supplier contracts can help optimize costs. A lean and well-managed cost structure can provide a competitive advantage, particularly in markets sensitive to price fluctuations.

Frequently Asked Questions

• How does a startup’s cost structure affect its business model?

The cost structure directly impacts a startup’s profitability, cash flow, and pricing strategy. A startup with a high variable cost structure might scale more efficiently but face greater risks during demand fluctuations, while one with higher fixed costs might have more predictable expenses but lower margins.

• Why is it important for startups to regularly review their cost structure?

Regular review of the cost structure allows startups to adapt to changing market conditions, optimize expenses, and explore new ways to increase efficiency and profitability. As the business scales, certain costs can be renegotiated or reduced, thereby impacting the bottom line positively.

• Can the cost structure influence a startup’s funding requirements?

The cost structure can significantly influence a startup’s funding needs. A business with substantial upfront fixed costs may require more initial capital, while one with variable costs might need funding that aligns more closely with growth or production scale.

Related Terms

Also see: Fixed Costs

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Project Management

How to create a cost breakdown structure (with examples).

May 9, 2024

‘How much will this project cost me?’

This is probably one of the most common but important questions that any client or internal stakeholder will ask you. And if the estimate you provide is not accurate or even close to realistic, it can put the project at risk. 

Of course, a cost estimate can’t always be accurate to the last dollar, but imagine quoting X for a project, only to realize you will require 2X the budget when the project actually begins.

Not a situation you want to find yourself in.

This is where a Cost Breakdown Structure (CBS) can help you get a clear picture of your project finances. It breaks down all the anticipated costs into manageable categories, giving you a clear picture of where your money goes. This empowers you to make informed budgeting decisions and manage project costs efficiently.

Plus, it will also help you track your project for potential cost overruns early on, helping you deliver the project on time and within the stipulated budget.

But what exactly is a CBS, and how does it differ from a work breakdown structure (WBS)?  We’ll explore these questions and more in this guide.

Why is cost breakdown structure important?

Difference between cost breakdown structure and work breakdown structure, 1. work breakdown structure, 2. identify costs involved in each activity, 3. understand cost opportunity, step 1: know all the activities and resource requirements, step 2: identify cost categories, step 3: estimate the cost of work, step 4: build a contingency plan for your cbs, step 5: sense check, cost breakdown structure analysis: a critical tool, implementing cbs with clickup, ace your project budget plan with clickup, frequently asked questions (faq).

What is a Cost Breakdown Structure in Project Management?

Project management involves managing multiple aspects of a project, including the scope, time, and cost. While keeping your project on track and meeting deadlines is crucial, staying within budget is equally important. This is where a cost breakdown structure (CBS) becomes an essential tool.

CBS is a document that details all the costs that will be incurred in a particular project. Each line or row in the CBS stands for a cost item associated with the project. It breaks down these costs into clearly defined categories, providing a detailed roadmap for your project finances.

In any project management lifecycle , the most critical part is ensuring that the project is delivered on time and within the stipulated budget. If either goes awry, there can be complications to the project’s overall success. With cost breakdown structures added to your project management strategy, you can:

• Improve budgeting and cost estimation by identifying all potential elements of the cost structure upfront. This allows you to avoid unpleasant surprises down the road and minimize the risk of expenses growing beyond a specific limit
• Plan your project more accurately , as you can identify potential project cost risks and activities early on, ensuring you can develop mitigation strategies or minimize the impact of these risks
• Clearly communicate the expectations of a project to all stakeholders, including clients, sponsors, and team members. This ensures transparency and ensures everyone is aligned on the project’s goal

Cost breakdown structure can seem a lot like work breakdown structure (WBS) since we list all the activities and stakeholders involved in both. However, while CBS focuses on cost control or managing project expenses, WBS is about understanding all the activities needed to deliver a successful project. 

Some of the subtle differences include:

Breaking Down the Cost Breakdown Structure

The cost breakdown structure is created using multiple components, including:

The foundation of your CBS is your WBS. This document outlines the project deliverables and tasks that make up your project. Think of it as a blueprint of what needs to be done.

For any CBS, there are four main cost categories to consider:

• Labor costs: Salaries, wages, and benefits of team members assigned to the task. Think of it as the cost of human effort
• Material costs: The raw materials, supplies, and equipment needed to complete the task. This could be anything from printer ink to lumber, depending on your project
• Equipment costs: Rentals or purchases of specialized equipment required for the task
• Indirect costs : These are factors other than the direct costs that can add up to your project budget. These include office rent, utilities, insurance, administrative costs, and more

CBS plan doesn’t just help with cost planning; it also helps you to understand potential courses of action. For example, if you have to create a website for a client.

If the cost of hiring external resources is much higher than expected, you can make proactive decisions like completing some tasks in-house. This helps minimize overall project costs and helps you take control over the project’s quality. 

How to Create a Cost Breakdown Structure

Now that you understand the power of a CBS, let’s delve into the practical steps involved in creating one. You can create detailed cost breakdown structures using project management software or a tool that helps you analyze or monitor all the activities and resources involved in a certain project. To create a detailed and accurate CBS, you can follow the steps below:

The first step to successful project planning and cost estimation is knowing the activities and resources needed for your project. This typically involves:

• Project scope document: This document outlines the project goals, deliverables, and timelines. It serves as the foundation for both your WBS and your CBS
• Work breakdown structure (WBS): A well-defined WBS is essential for your CBS. It provides the framework for identifying cost elements associated with each project task
• Cost estimation tools: Various cost estimation tools are available, ranging from simple spreadsheets to more sophisticated software. Choose a method that best suits your project’s complexity and budget

The next step is estimating the required cost for each task, activity, or resource. These tasks can be divided into multiple aspects depending on their impact and work area, such as:

• Labor costs: Salaries, wages, and benefits of team members assigned to the tasks.
• Material costs: Raw materials, supplies, and equipment needed to complete the tasks.
• Equipment costs: Rentals or purchases of specialized equipment required for the tasks
• Office rent and utilities
• Administrative costs
• Software subscriptions

By considering both direct and indirect costs, you minimize the risks of any unknown task or cost factor being added to your budget. 

Once you have factored in all the cost factors that will impact your budget, it is time to start estimating the cost of completing a particular action item . For example, if you want to conduct X task, how much time do your team members take to complete it? How many resources will they need to complete it? These answers allow you to factor in the overall budget needed to complete X task.

Once you have done this for all the tasks in your project, it can be used to provide a final cost for the project. This is a crucial process, especially when estimating the budget for large-scale projects like construction projects. 

By closely tracking the tasks and resources required for a particular project and other impacts using construction management software , you can ensure that your projects get completed within the defined timeline and budget. 

Even after meticulous planning, unforeseen events can add to your project costs. For example, if you have to purchase materials from a supplier and they are out of stock, you may need to procure them from another source. The cost for these can be higher, or you may even have to pay extra to the same supplier if the materials you need are low on stock. 

To mitigate these risks, include a contingency margin in your CBS. This is a buffer allocated for unexpected expenses that might arise during the project. The size of your contingency margin will depend on the inherent risk factors associated with your project.

To jump-start your planning, use the ClickUp Contingency Plan Template and keep your business safe and secure.

This template offers you both list and board views, helping you draw your Contingency Plan and use it effectively for your projects. It helps you create a clear roadmap for unexpected events by:

• Analyzing potential risks and their impact on your operations
• Identifying necessary resources and personnel
• Testing alternative scenarios to ensure the best-case outcomes

The last step in creating a cost breakdown structure is thoroughly reviewing your plan. Look for any inconsistencies or missing information. Share your CBS with key stakeholders for input and finalize the document after incorporating their feedback.

For any project, delays are often costly. For example, if we were a construction firm, a small delay in procuring resources could mean stalling of work, and this would end up increasing the expenditure of the overall project. This is why using CBS analysis is crucial for organizations. 

With regular cost breakdown structure analysis, you can ensure that your project financials and timelines are constantly monitored, helping eliminate cost risks . This also helps with:

• Proactive cost management, as you can identify cost overruns early on and take corrective actions, such as adjusting resource allocation or negotiating with suppliers, to stay within budget
• Improving project control and management, as you can monitor aspects of WBS when analyzing your CBS documentation
• Identifying potential risks , including cost or resource planning, enabling you to minimize their impact on your overall project

When conducting a CBS analysis, make sure you look for standard impacts to your project, such as:

• Cost variances: Track any deviations between budgeted costs and actual costs incurred. Analyze the reasons for these variances and take corrective actions as needed.
• Project milestones: Conduct a CBS analysis at key project milestones to assess financial performance and identify areas for course correction. Use Milestones in ClickUp to visualize your goals at a glance and ensure you are well on track to achieve them.
• Project scope changes: Any changes to the project scope can impact costs.  Analyze your CBS to understand the financial implications of scope changes and ensure they are aligned with the overall budget.

To get the most accurate estimate for your project, you need to be able to break down all the tasks, including all the resources, actual costs, logistics costs, and every activity involved. For most companies, this often proves to be difficult as all their activities and teams work in silos and on different platforms.

This is where an end-to-end project management software like ClickUp can help make things much more streamlined and efficient. 

ClickUp goes beyond basic task management, offering a robust suite of features that perfectly complement your CBS needs. With it, you can:

• Break down project deliverables into manageable tasks and subtasks, creating a clear visual roadmap. This enables you to better estimate the project budget based on the activities and resources involved
• Track associated costs by assigning estimated costs to each task, categorize expenses, and track actual costs incurred. This provides a centralized location for managing all project finances
• Visualize cost breakdowns by category, track budget variances, and gain valuable insights into project financials
• Share your CBS document with team members, assign tasks with cost estimates, and keep everyone informed on project finances through real-time updates

With ClickUp Project Management , you get advanced features that can help you:

• Plan and prioritize all your project details with ease, helping your entire team get a clear understanding of the scope, allocation, and activities
• Leverage ClickUp Brain , an AI-based project management assistant, to simplify your day-to-day work.  It can automatically generate action items and subtasks, summarize comment threads, create data tables, find relevant details within ClickUp and connected apps, and create and share automated progress updates. Use it as your AI project manager
• Gain consensus faster and kickstart projects with clarity using a single platform to collaborate on your project vision, estimate costs, and deliver projects faster and on budget

It also provides ready-to-use, fully customizable estimation templates to help you get started with CBS and WBS project estimations instantly. For instance, the ClickUp Project Budget with WBS Template makes cost tracking easy and simple by breaking your project into tasks.

Using this template, you can simplify project budgeting activities as it allows you to:

• Map out activities and cost estimates
• Organize all your project data in one place
• Track your spending continuously so you do not go over budget

It includes a detailed work breakdown structure (WBS), including:

• Custom Statuses: To mark task status as Cancelled, Done, In Progress, On Hold, and To Do
• Custom Fields: To categorize and add attributes to manage your tasks and easily visualize your project activities and budget
• Custom Views: To visualize your information in multiple views for project tracking and management
• Project Management: Improve project budget and WBS tracking with time-tracking capabilities, tags, dependency warnings, emails, and more

These templates provide a pre-defined structure for your WBS, cost estimation fields, and budget tracking functionalities without having to do all the tasks manually or start from scratch.

So here’s the ultimate guide to help you ace project planning and estimate project budgets. It provides a clear and comprehensive picture of your project finances, empowering you to make informed budgeting decisions, identify potential cost risks proactively, and ultimately deliver projects on time and within budget.

With ClickUp, you can make your entire project management process much more effective and track budgets and tasks on the same platform.

Whether it’s project managers or your finance or commercial department, they can all work together, plan projects, and collaborate as required. Or, as Michael Scott would say, it’s a triple WIN.

The all-in-one project management software lets you manage workflows, documents, real-time dashboards, and more, helping your team move faster, work smarter, and save time.

Ready to take control of your project costs? Sign up for ClickUp today and experience the benefits of a streamlined and collaborative CBS approach!

1. What is included in a cost breakdown structure?

A cost breakdown structure (CBS) includes all the costs incurred in a certain project. This includes four main cost categories:

• Labor costs : The money spent on the people who will execute the project
• Material costs : Any materials that the business buys, including raw materials, parts and components, manufacturing supplies, insurance, and freight
• Equipment costs: The actual equipment
• Overhead costs or indirect costs: Expenses not directly allocated to a specific cost, such as office space, utilities, benefits, and taxes

2. What is the cost breakdown method?

The cost breakdown method refers to the process of creating a cost breakdown structure. This involves identifying all project activities from the Work Breakdown Structure (WBS), assigning costs to each activity, and summing them up to get the total project budget.

3. What is the difference between a cost breakdown structure and a work breakdown structure (WBS)?

A Work Breakdown Structure (WBS) outlines the project deliverables by breaking them down into smaller, more manageable tasks. A CBS focuses on the financial aspects of the project, assigning costs to each element of the WBS. Together, they provide a comprehensive view of project scope and finances.

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How to create a budget for your business

January 16, 2024 | 7 minute read

If you want to increase the odds of having a successful small business, start by creating a budget. A budget is a powerful tool. It helps you understand how much money you have and what you’ve spent where — and provides clues about how much money you’ll need in the short and long term. It can also help shape key business decisions like whether to add staff and equipment or where to cut expenses to avoid cash flow issues .

A budget is critical, particularly at a time when companies are coping with rising costs. Seventy-nine percent of small business owners polled in Bank of America’s 2023 Small Business Owner Report said they are concerned about inflation and 68% said they are worried about commodity prices. Here’s how to create a budget and use it to make the best decisions today, tomorrow and in the future.

What is a business budget?

Simply put, a budget is a spending plan based on your business’ income and expenses. It shows your available capital, estimates spending and assists in predicting revenue. The information in your budget can help you plan your company’s next moves. A budget looks at activities for a specified time. Think of it as a tool to help you allocate resources toward the strategic priorities in your business plan.

What are the benefits of creating a business budget?

Budgeting enables you to allocate financial resources more effectively, track variances and make changes to your spending plan as needed. A budget provides a much-needed assist in maintaining daily operations, giving you the intel to deploy your cash more strategically so you don’t face a cash flow crunch. It can identify when you need to raise financing. Debt is a fact of life in many businesses. A budget can help you manage debts with controlled and planned financial activities.

A budget can also help you stay ready for the unexpected. Staying within your budget and creating a safety net for emergencies will give you a firmer financial foundation.

Types of business budgets

When it comes to business budgets, it’s not one and done. There are several types that may be helpful in your business.

Master budget

This type of budget uses inputs from financial statements, your cash forecast and your financial plan to create a single document you can use to keep your finger on the pulse of your business. Your management team can use it to plan the activities needed to reach business goals. Typically, small businesses use spreadsheets to create their master budgets or consider using budgeting software too, as it may help minimize mistakes.

Operating budget

This budget shows your projected revenue and expenses for a given period. Think of it as a profit and loss report , but for the future. The operating budget includes fixed and variable costs, as well as non-operating expenses. Capital expenditures are usually excluded from an operating budget. Each line item should be backed up with key details.

Fixed costs occur monthly.

Variable costs, like utilities , change depending on factors like usage.

Capital costs are one-time expenses, such as the purchase of a building.

The operating budget gives you a reality check on whether you’re spending according to plan. While this budget is often prepared at the start of each year, don’t set it and forget it. Update it throughout the year, be it monthly or quarterly, so you always know where your business stands.

Capital budget

Companies sometimes create a capital budget when they are looking to make a large purchase, such as a large piece of factory equipment or a new technology system that will require a substantial investment. This allows the finance team to determine the impact on cash flow and plan accordingly.

Cash budget or cash flow budget

This document will give you an estimate of how money comes in and goes out during a certain time horizon. You create a cash budget using the conclusions you draw from sales forecasts and production, and by estimating payables and receivables.

Labor budget

If you will hire employees , this type of budget is helpful in planning for the money you’ll need to meet payroll, not only for regular employees, but also for any temporary and seasonal staff.

Budgeting methods you can use

There’s more than one way to budget. Here are some common methods:

An incremental budget

This takes the current period’s budget or actual performance, uses it as a base and then adjusts it in incremental amounts to account for any increases in costs. Typically, when you put together an incremental budget, you use the rate of inflation as a guide for fine-tuning the amounts. One plus of budgeting this way is that it is relatively easy to do.

Zero-based budgeting

Here, you’re budgeting from scratch. You must scrutinize every expense or potential expense before deciding to add it to your budget. This helps you align your business goals with your expenses. Unlike other types of budgeting, it doesn’t focus on historical results. A zero-based budget is ideal when you’re looking to reduce expenses.

Activity-based budgeting

Actions speak louder than words. This type of budgeting looks at the inputs required to reach the targets or outputs set by the company. Say your business wants to achieve $5 million in revenue. First, you need to figure out the activities that need to happen to make that revenue a reality and then determine the costs of carrying out those activities.

Participative budgeting

There are more cooks in the kitchen with participative budgeting, which is often used by larger small businesses. Both middle management and lower levels of management share in the responsibility of putting together the budget. The budget begins with lower management then moves to middle managers before top management weighs in and signs off. An upside of this type of budgeting is that information is shared, and when management and staff are on the same page in terms of goals, they’re more likely to achieve those goals.

How to create a business budget

Creating a business budget takes several steps:

• Calculate your revenue . Include all your revenue streams, preferably over at least the last 12 months, to determine your monthly income. If your business is new, you can research what’s typical in your industry and use that as a guide to come up with estimates.
• Add up your fixed costs . Fixed costs are things like rent, payroll and debt repayment.
• Determine variable costs . In addition to utilities, these may include billable labor, materials, transaction fees and commissions.

Using a budget to make better decisions

If you make your budget a regular resource, you’ll be rewarded for your budgeting efforts. As you make spending decisions, consult your budget frequently and use it as a reality check. If you have budgeted for X amount and go beyond it, you’ll have some explaining to do, even if you’re only answering to yourself. Being disciplined can be challenging, but ultimately it will position your business for growth , both today and in the future.

Explore more

How to create a sales forecast

Understanding free cash flow

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