Overview
The cost structure of a firm is a key strategic concern. Companies that face high costs that cannot easily be addressed can find that they are unable to compete on price or to entice the necessary talent to sustain a competitive advantage.
Considerations
- High Fixed Costs -
The cost structure of an industry often determines how profitable the industry is.
(see Porter Five Forces
for a breakdown of industry structure and profitability)
Companies with high fixed costs often face challenges when the economy or consumer spending turns down. Whereas a company with all variable costs can reduce its costs by reducing the amount of product produced and sold, the firm with fixed costs will incur those costs regardless of the amount of product produced and sold.
In these cases, these firms tend to fight to retain or gain market share in a downturn, often engaging in price wars in order to just cover their fixed costs. - Experience Curve - companies that face economies of scale can sometimes capture a commanding profitable position in their market by beginning a price war. By cutting prices, these firms begin to capture market share. This pushes them down the cost curve through the economies of scale. Once they achieve a cost structure that is more efficient than their competitors, they can effectively price them out of the market.