Module 9: Profit Maximization and Supply

 

THE POLICY QUESTION
WILL A CARBON TAX HARM THE ECONOMY?

Carbon emissions in the atmosphere due to human activity have been identified as the key component of global warming. We know from earlier chapters that the cost of consumption influences human choices. Therefore, a very popular policy proposal to address global warming is to impose a tax on carbon at the source. For example, the state of California and the Canadian province of British Columbia began imposing a carbon tax in 2015 and 2008, respectively. Carbon taxes generally increase the price of fossil fuels, which have a large carbon component. The result is an increase in energy prices for all users. Critics of these policies suggest that carbon taxes would have an adverse impact on the economy greater than any potential benefit.

To analyze the impact on the economy, we must start with the individual actors upon which the economy depends: the firms themselves. This chapter examines how firms make decisions about how much to produce and how their profits are determined. Once we have developed a general model, we can use it to analyze the impact of a carbon tax on individual firms, understand the firm-level implications of the tax, and know the right questions to ask when trying to determine the cost and benefits of a carbon tax.

In this chapter, we will study the supply side of markets: how firms’ cost conditions define and affect their supply curves and the market supply curve. By summing up all producers’ supply curves within a given industry, we can construct a market supply curve just as we constructed the market demand curve from individual demand curves. When we have both market demand and market supply, we will be able to study market equilibrium in section 9.3.

EXPLORING THE POLICY QUESTION

• How does a tax on carbon affect individual firms’ output and profits?

9.1 OUTPUT DECISIONS FOR PRICE-TAKING FIRMS

Learning Objective 9.1: Explain how competitive, price-taking firms decide on output levels.

Before considering the production decisions of firms, we need to understand a few foundation ideas. First, we are focusing on the behavior of price-taking firms. A firm is said to be a price taker when it has no ability to influence the price the market will pay for its product; it must take the market price as determined by the laws of supply and demand in a competitive market. A perfectly competitive market is a market in which there are many firms so that each individual firm’s output has no impact on market equilibrium, output is identical across firms, firms have the same access to inputs and technology, and consumers have perfect information about prices. All firms in a perfectly competitive market are price takers.

Second, we are focusing on firms that are motivated by profit. Many publicly and privately owned firms have one main objective: to maximize profits. Not-for-profit firms seek to maximize some other objective, like providing a social service such as mental health care to the greatest number of people in need, but these are a tiny fraction of all firms in the world. In this chapter, we will assume that firms’ objectives are to maximize profits.

A firm’s profit ($\pi$) is the difference between its total revenue and its total cost:

(9.1)$\pi \left(Q\right)=TR\left(Q\right)-C\left(Q\right)$

The total revenue is the quantity of the goods produced multiplied by the sales price of those goods.

$TR\left(Q\right)=PQ$

The total cost is the total cost curve $C\left(Q\right)$ introduced in chapter 7 and represents the economic cost. The economic cost is the cost inclusive of all opportunity costs, so it includes both explicit costs and implicit costs. This is distinct from the accounting cost, which includes only the explicit costs, or those you would see in an accounting spreadsheet of the firm’s costs. So equation (9.1) is an expression of the economic profits of the firm, which consider economic costs. In economics, we focus exclusively on economic profits because this is the relevant measure when it comes to decision-making.

To understand the difference between accounting cost and economic cost, imagine deciding whether to open up and run a small business making and selling soap infused with organic botanicals. Suppose you figure that your business will achieve annual sales of $230,000 and your out-of-pocket cost for the ingredients, equipment rental, property rental, and so on is $155,000 annually. Your accounting profits after a year would be $\$230,000-\$155,000=\$75,000$, a pretty decent return.

But should you go ahead and start the business? To answer that, you need to think about your opportunity cost. What would you do instead if you decided not to start your own business? Imagine that your friend has offered to hire you to work in her firm, and she will pay you an annual salary of $90,000. Imagine also that you think you would be equally satisfied working with your friend as running your own business. With this in mind, your annual economic costs of running your business is $\$155,000+\$90,000=\$245,000$. So your annual economic profit would be $\$230,000-\$245,000=-\$15,000$. The answer is now clear—your best decision is not to run a business making soap but to work with your friend.

Let’s now turn to the output choice of a profit maximizing, price-taking firm. The objective of maximizing profit means that firms must choose the output level that maximizes the difference between total revenue and total profit. To determine this specific level of output, the firm must ask how the production of one more unit of output contributes to both the total revenue and the total cost. For example, if a car manufacturer can produce one more car at a marginal cost of $15,500 and sell that car for a marginal revenue of $17,000, it knows that by producing the extra car, its profits will increase by $1,500. Note that this is not the same as knowing that profits are positive because the calculation does not include fixed costs. Similarly, if the additional car has a marginal cost of $18,000 to produce and can be sold for $17,000, then the manufacture and sale of this car would reduce profits by $1,000.

The term marginal revenue $\left(MR\right)$, used in our example above, refers to the change in total revenue from a one-unit change in quantity produced. Marginal revenue is expressed as

$MR=\Delta TR/\Delta Q$.

Calculus

The marginal revenue is the rate of change of total revenue as output increases, or the slope of the total revenue functions, $TR\left(Q\right)$. To find this, we take the derivative of the total revenue function:

$MR\left(Q\right)=\frac{dTR\left(Q\right)}{dQ}$.

For a price-taking firm, this increase in revenue from the sale of an additional unit is exactly the price of that unit. In other words, for a price-taking firm, $MR=P$.

Any profit maximizing firm would like to continue to increase output as long as marginal revenue is larger than marginal cost. A profit maximizing firm would also like to reduce output as long as marginal revenue is lower than marginal cost. The incentive to increase or decrease output stops exactly when marginal revenue equals marginal cost. This is known as the profit maximization rule: profit is maximized when output is set where marginal revenue equals marginal cost.

From chapter 8, we learned that marginal cost ($MC)$ is the additional cost incurred from the production of one more unit of output:

$MC=\Delta C/\Delta Q$

Since the profit maximizing rule stipulates that output should be set where marginal revenue equals marginal cost and since marginal revenue for a price-taking firm is the price of the good, we know that at the profit maximizing output level for the firm,

$P=MC\left(Q\right)$.

The expression $P=MC\left(Q\right)$ gives us a relationship between the price, $P$, of a good and the quantity, $Q$, that a profit maximizing, price-taking firm will produce at that price. In other words, it gives us the individual firm’s supply curve. Figure 9.1.1 illustrates this relationship.

Figure 9.1.1 Profit maximization for a price-taking competitive firm

In figure 9.1.1, we see that the firm’s profit maximizing level of output is where marginal revenue equals marginal cost. For a price-taking firm, marginal revenue is equal to the price. So as price increases, the firm will increase production, and when the price decreases, the firm will decrease production.

9.2 SHORT-RUN SUPPLY

Learning Objective 9.2: Describe how competitive firms make decisions on short-run output and whether to shut down if they experience negative profit.

To understand the short-run supply decision of the firm, we have to be able to measure the firm’s profits. The profit maximization rule, to set output so that marginal revenue equals marginal cost, ensures that the firm is maximizing profit, but it does not ensure that the firm is making positive profits. In other words, following the $MR=MC$ rule means that the firm is doing the best it can, which could be minimizing losses instead of making positive profits.

To see how we go from the output decision to profits, consider the following:

$\Pi =TR-TC$

$TR=PQ$

$TC=ATC\times Q$
$(\text{since}ATC=\frac{TC}{Q})$

Thus,

$\Pi =\left(PxQ\right)-(ATC\times Q)$

$=(P-ATC)Q$.

Since $Q^{\ast }$, the quantity for which $MR=MC$, is always positive or zero, whether profit ($\pi$) is positive or negative depends on the price $\left(P\right)$ relative to the average total cost at that particular $Q^{\ast }\left(AT{C}^{\ast }\right)$. If $P>AT{C}^{\ast }$, then $\pi >0$, as seen in figure 9.2.1. In the figure, profits ($\pi$) are represented graphically by the shaded area. Notice that the height of the rectangular shaded area is $P-ATC$ and the width is Q. Since the area of a rectangle is height times width, the area of this rectangle equals the profit.

Figure 9.2.1 Positive profit $P>AT{C}^{\ast }$

If $P=AT{C}^{\ast }$, then $\pi =0$, as seen in figure 9.2.2.

Figure 9.2.2 Zero profit $P=AT{C}^{\ast }$

If $P<AT{C}^{\ast }$, then $\pi <0$, as seen in figure 9.2.3.

Figure 9.2.3 Negative profit (loss) $P<AT{C}^{\ast }$

It is tempting to think that if profit is negative, the firm should immediately shut down or cease production of the good. But remember that in the short run, there are fixed inputs that cannot be adjusted immediately. For example, suppose the soap-selling business requires the leasing of a storefront. This is a three-month lease, and three monthly payments of $1,000 each must be made regardless of whether the store is open or closed. Now suppose that the business is making enough revenue to cover all the variable costs, like the ingredients for the soap, the electricity bill, your own salary, and part of the lease, perhaps $500 of the $1,000. If you continue to operate the store, you will lose $500 per month—the part of the lease payment not covered by revenues. If you shut down, you will lose $1,000 per month until the lease runs out, because although there are no variable costs, there also is no revenue.

Consider the following expression for profit:

$\pi =TR-TC$

$=TR-FC+VC$

$=TR\left(Q\right)-FC-VC\left(Q\right)$

The third line in this expression shows that $TR$ and $VC$ are both functions of $Q$, so if $Q=0$, then $TR=0$ and $VC=0$ as well. Shutting down means to set $Q=0$.

The level of profit if the firm shuts down is $\pi =0-FC-0=-FC$.

So in the short run, a firm should only shut down if the total revenue is lower than the variable cost, which is the same as the price being lower than the average variable cost.

Figure 9.2.4 illustrates the situation where the firm is generating a negative profit but should continue to operate in the short run. At $Q^{\ast }$, the firm is making negative economic profits because $(P-AT{C}^{\ast })$ is negative $\pi =(P-AT{C}^{\ast })Q^{\ast })$. However, the firm is covering all its variable costs $(P>AV{C}^{\ast })$ and part of its fixed costs. Of course, when the short run ends because the firm is able to adjust its previously fixed input, the firm should shut down if its total revenue is still lower than its total cost.

Figure 9.2.4 Negative profit, but in the short run, firm should continue to operate.

This understanding of the short-run output decision allows us to derive the firm’s short-run supply curve. As long as the market price is above the firm’s average variable cost, the firm will choose to produce an output where $P=MC$. In other words, the firm’s marginal cost curve above the $AVC$ curve is the firm’s supply curve. When price is below $AVC$, the firm chooses not to produce any output at all, so the supply for prices below $AVC$ is zero. Figure 9.2.5 illustrates the firm’s short-run supply curve.

Figure 9.2.5 Competitive firm’s short-run supply curve

Every firm in a given industry has a short-run supply curve, but its precise shape depends on the firm’s cost structure—the shape and location of its $MC$ and $AVC$ curves. Because each individual firm supplies a certain amount of output at every price, we can derive the industry supply curve by simply adding up these outputs across all firms in the industry. When we do this, we must take care to sum the quantities at every price, not the other way around.

Figure 9.2.6 shows how summing up all individual short-run supply curves yields the industry short-run supply curve, which represents the quantity supplied in the short run at every price.

Figure 9.2.6 Deriving an industry short-run supply curve

9.3 LONG-RUN SUPPLY AND MARKET EQUILIBRIUM

Learning Objective 9.3: Describe competitive firms’ long-run supply curves and how firms’ entry and exit affect the long-run market equilibrium.

In the long run, firms do not have any fixed costs; all production costs are variable. So a firm’s profitability is determined solely by the long-run average total cost curve. A profit maximizing firm still sets output so that marginal revenue equals marginal cost, and since marginal revenue for a perfectly competitive firm is equal to the market price, the marginal cost curve above the long-run average total cost curve $\left(LRATC\right)$ represents the firm’s supply curve.

As in the short-run case, the firm’s profits depend on the price relative to the long-run average total cost at the optimal output level for the firm, $Q^{\ast }$. In figure 9.3.1, the price is above $LRATC$, so the firm is making positive profits. As long as profits are not negative, the firm will continue to produce.

Figure 9.3.1 Positive profits in the long run

So the portion of the long-run marginal cost $\left(LRMC\right)$ that lies above the $LRATC$ is the firm’s supply curve, as seen in figure 9.3.2.

Figure 9.3.2 The long-run supply curve of a perfectly competitive firm

To derive the long-run market supply curve, we have to think about how firms enter and exit industries in the long run. We assume perfectly competitive industries have free entry and free exit: there are no special costs, such as technical or legal barriers, to firms entering and exiting the industry. This assumption is critical to perfect competition. Barriers that block firms from entering or exiting will create an environment that has only limited competition.

Barriers to Free Entry and Free Exit

Barriers to entry and exit can be legal, such as patents that limit the production of a good to the firm that invented it, or technical, such as the cost of setting up a network of wires to homes for a company that wishes to provide cable television services. We will study such barriers in more detail when we discuss monopolies in chapter 16.

If free entry and exit exist, the next question to answer is, When will firms choose to enter and exit a market? To answer this question, we will assume for now that all firms in a market are homogeneous—that is, they have identical technologies and cost structures, or more simply, they all have the same $LRATC$ and $LRMC$ curves. We will examine firms that have different costs in the next section of this chapter.

Figure 9.3.1 illustrates the case where the market price is such that the firm is making positive profits. Positive profits in this case mean that the firm is getting better than normal returns or that this is an exceptionally profitable market to be in. Other firms, not currently in the market, will see these profits and decide that this is a good market to enter. When new firms enter the market, they provide their output to the total supply, and the market supply increases.

As illustrated in figure 9.3.3, as new firms, drawn by positive profits, enter the market, the added supply lowers the equilibrium price—the price at which quantity demanded equals the quantity supplied. This lowering of the equilibrium price lowers all firms’ profits.

Figure 9.3.3 New entrants increase market supply and lower equilibrium price.

Entry will continue to occur as long as firms’ profits are positive, and so this process will continue until the equilibrium price has reached the point where the $LRATC$ and the $LRMC$ cross, or where there are zero profits, as shown in figure 9.3.4.

Figure 9.3.4 Equilibrium with zero profits

Equilibrium with zero profits actually includes two kinds of equilibrium:

1. A market equilibrium where the price equates the quantity supplied to the quantity demanded
2. An equilibrium in the number of firms in the market, as the zero profit experienced by the existing firms in the market does not attract any new entrants

The market exit dynamics work similarly to the market entry dynamics. Firms that are currently producing and supplying their output to a market where the equilibrium price is below their $LRATC$ are making negative profits, which by the definition of opportunity cost means that other opportunities exist that yield higher returns. This fact will cause the existing firm to want to exit the market.

A firm’s profit is negative when the equilibrium price is below the firm’s $LRATC$ at its profit maximizing level of output. In this case, profit maximization is synonymous with loss minimization—the firm is making the best output choice it can. Figure 9.3.5 illustrates a situation of long-run negative profits for a firm.

Figure 9.3.5 Negative profits in the long run

Will all firms exit the market when profits are negative? No, because as the first firms exit the market, supply will fall, and the equilibrium price will rise. Figure 9.3.6 illustrates this behavior graphically. Once the price rises to the point where it equals $LRATC$, there will no longer be an incentive for firms to leave the market.

Figure 9.3.6 Exiting firms cause a market supply decrease and a rise in the equilibrium price

The long-run entry and exit dynamic allows us to understand the long-run market supply curve. Entry and exit dynamics will always force the price back to $P_1$ in the long run, as new firms enter to satisfy any new demand and existing firms exit when demand falls. The resulting long-run supply curve is horizontal, as shown in figure 9.3.7.

Figure 9.3.7 The long-run market supply curve

9.4 HETEROGENEOUS FIRMS AND INCREASING AND DECREASING COST INDUSTRIES

Learning Objective 9.4: Demonstrate how increasing and decreasing cost industries affect the long-run market supply curve.

In the previous section, we explicitly assumed homogeneous firms—that is, firms all having identical costs. We also assumed, implicitly, that costs were constant as industry output changed. In this section, we will study what happens when these assumptions do not hold.

Consider first a number of firms that all produce the same good but that all have different costs—that is, heterogeneous firms. It makes sense that the firms with the lowest costs would be the first to provide their output to the market and that they would experience positive profit. Their success would attract new entrants to the market, just as in the case of homogeneous firms. Each new entrant can be expected to be the next lowest-cost firm. Entry will continue until profits reach zero for the most recent entrant, causing it to become the last entrant.

Zero profits will happen when the supply increases enough to push price down to equal the marginal cost of the very last entrant. Since the entrants that came before the last one all have lower costs, they will all continue to experience positive profits. No other firms will enter after the last zero-profit entrant because they are, by assumption, higher-cost firms and will earn negative profits if they do so. After profits reach zero, new entrants will be drawn in only if the price rises.

In the case of heterogeneous firms, the long-run supply curve will be upward sloping, even in the case of perfect competition, as seen in figure 9.4.1.

Figure 9.4.1 Long-run supply in the case of firms with different costs

The second assumption that was implicit in the previous section is that firms are in a constant-cost industry: industries where firms’ costs do not change as industry output changes. So no matter how much total output there is in the industry, all the $LRATC$ curves remain in the same place.

This assumption does not hold for many industries. Some industries are increasing-cost industries: industries where firms’ costs increase as industry output increases. This can happen because as an industry expands the demand for inputs or industry-specific capital increases, which can cause the prices to rise. For example, if the demand for coffee increases due to positive news about the health benefits of consumption, the demand for coffee beans will increase as well, which could lead to an increase in their price. As the industry output increases, the costs of all firms will increase, and the long-run supply curve will slope upward, as shown in figure 9.4.2(a).

Other industries might be decreasing-cost industries: industries where firms’ costs decrease as industry output increases. This could be because these industries have increasing returns to scale or because increased demand for inputs and capital leads to increased returns to scale on the part of the firms that supply these goods. For example, if the demand for coffee increases the demand for espresso machines, espresso machine manufacturers might invest in cost-saving technologies, such as automating parts of the assembly process. As the coffee industry output increases, the cost of espresso machines decreases, the costs of coffee shops decrease, and the long-run supply curve would be downward sloping, as shown in figure 9.4.2(b).

Figure 9.4.2 Long-run supply curves for increasing and decreasing cost industries

The heterogeneity of a firm’s cost structures and the fact that many or most industries could be described as increasing cost industries lead economists to generally draw the market supply curve as upward sloping. From the information learned in this chapter, you can now see that the market supply curve comes from the firms themselves.

9.5 POLICY EXAMPLE
WILL A CARBON TAX HARM THE ECONOMY?

Learning Objective 9.5: Predict the effect of a carbon tax on the supply and profit maximization decisions of firms on which it is imposed.

On July 1, 2008, in response to mounting evidence that human activity is contributing to global climate change and that carbon emissions are a key factor in rising earth temperatures, the Canadian province of British Columbia began collecting a tax on carbon emissions. In so doing, British Columbia became the first North American jurisdiction to levy a carbon tax.

The government of British Columbia charges a tax on revenue from the sale of all fuels: gasoline, diesel, natural gas, propane, jet fuel, and coal. This tax is neutral, meaning the proceeds are returned to the citizens of the province through a reduction in income taxes and tax credits.

Though a carbon tax is a popular policy proposal for groups concerned about climate change and greenhouse gases, pro-business groups generally resist it, arguing that carbon taxes would do great harm to the economy. In this chapter, we have studied how cost conditions translate into firm and market supply. Given this analysis, we can come up with a prediction about the way that a carbon tax would affect firms’ production behavior.

Carbon taxes raise the price of energy, which is a production input. Energy usage generally, but not always, varies with the level of output. More intense production is generally associated with higher energy use. So we can assume that the energy input of firms is a variable cost. This means that an increase in the cost of energy will increase not only the total costs of the firms but their marginal costs as well. In figure 9.5.1, we can see the resulting impact on firms and their marginal cost curves.

Figure 9.5.1 Effect of an increase in variable cost

From this we can anticipate that firms’ supply curves will rise and that the new equilibrium price will increase. So business groups have a legitimate point in worrying about the effect of a carbon tax on firms’ costs. The effect on an individual firm is clear from figure 9.5.1—this tax will lead it to charge higher prices and reduce output.

However, this is only part of the story. Revenue-neutral carbon taxes will increase demand through income tax rebates and credits, which would serve to raise the equilibrium price. This could offset, at least in part, the rise in costs. A true analysis of this policy would also include the economic impact of climate change itself and the benefit of carbon mitigation. This is a subject we will return to in chapter 20, “Externalities.”

EXPLORING THE POLICY QUESTION

1. If a carbon tax is imposed, the costs in a perfectly competitive industry would likely rise. If firms make zero profits prior to the tax and zero profits after the tax, is it correct to say that there is no net effect of the tax?
2. Another policy response to combat carbon emissions is to mandate reductions in energy usage on the part of firms. Using the theory of profit maximizing competitive firms, analyze the impact of this alternate policy.
3. What else would you want to know about carbon emissions, climate change, and the economy to give a full cost-benefit analysis of a carbon tax?

LEARN: KEY TOPICS

Terms

Profit $\left(\pi \right)$

Profit maximization rule $(MR=MC)$

Marginal revenue $\left(MR\right)$

Marginal cost $\left(MC\right)$

Short-run supply

Long-run supply $\left(LRATC\right)$

Shut-down rule

Constant-cost industry

Increasing-cost industry

Decreasing-cost industry

Free entry and exit

Graphs

Profit maximization for a price-taking competitive firm

Positive profit

Zero profit

Negative profit (loss)

Negative profit, but in the short run, firm should continue to operate

Competitive firm’s short-run supply curve

Positive profits in the long run

The long-run supply curve of a perfectly competitive firm

New entrants increase market supply and lower equilibrium price.

Equilibrium with zero profits

Negative profits in the long run

Exiting firms cause a market supply decrease and a rise in the equilibrium price

The long-run market supply curve

Long-run supply in the case of firms with different costs

Long-run cost curves for increasing and decreasing cost industries

Equations

Profit

Profit $\left(\pi \right)$

A firm’s profit ($\pi$) is the difference between its total revenue and its total cost

$\pi \left(Q\right)=TR\left(Q\right)-C\left(Q\right)$

Total Revenue $\left(TR\right)$

The total revenue is the quantity of the goods produced multiplied by the sales price of those goods.

$TR\left(Q\right)=PQ$

The total cost is the total cost curve $C\left(Q\right)$ introduced in chapter 7 and represents the economic cost.

From Output Decision $\left(Q\right)$ to Profits $\left(\pi \right)$

The profit maximization rule ($MR=MC$) ensures that the firm is maximizing profit, but it does not ensure that the firm is making positive profits; the firm could be minimizing losses instead of making positive profits. The relationship between output decisions and profits can be mathematically expressed:

$\Pi =TR-TC$
$TR=PQ$
$TC=ATC\times Q$
$(\text{since}ATC=\frac{TC}{Q})$

Thus,

$\Pi =\left(PxQ\right)-(ATC\times Q)$
$=(P-ATC)Q$

Since $Q^{\ast }$–the quantity for which $MR=MC$–is always positive or zero, whether profit ($\pi$) is positive or negative depends on the price $\left(P\right)$ relative to the average total cost at that particular $Q^{\ast }\left(AT{C}^{\ast }\right)$. If $P>AT{C}^{\ast }$, then $\pi >0$. See figure 9.2.1 and 9.2.2.

Marginal cost

Marginal cost (MC) is the additional cost incurred from the production of one more unit of output:

$MC=\Delta C/\Delta Q$

 stipulates that output should be set where marginal revenue equals marginal cost; marginal revenue for a price-taking firm is the price of the good, therefore

$P=MC\left(Q\right)$

Marginal revenue

The change in total revenue from a one-unit change in quantity produced. Marginal revenue is expressed as

$MR=\Delta TR/\Delta Q$

For a price-taking firm, this increase in revenue from the sale of an additional unit is exactly the price of that unit. In other words, for a price-taking firm,

$MR=P$

The Relationship Between Price $\left(P\right)$ and Output $\left(Q\right)$

Since marginal cost is the additional cost incurred from the production of one more unit of output:

$MC=\Delta C/\Delta Q$

and the profit maximizing rule stipulates that output should be set where marginal revenue equals marginal cost:

$MR=MC$

and since marginal revenue for the price-taking firm is the price of the good:

$MR=P$

a relationship between output $\left(Q\right)$ and price $\left(P\right)$ can be established:

$P=MC\left(Q\right)$

 https://cutt.ly/D8oGdEf

Business Model Canvas For Beginners. 9. Cost Structure – How To Minimize Costs And Maximize Value

 In this last section, I’ll walk you through the cost structure building block of the business model canvas. I’ll explain the different types of costs and show you the key questions every entrepreneur must be able to confidently respond to when analysing the business model.

You will learn about the different types of cost structure: fixed and variable costs and they can have benefits through economies of scale or economies of scope.

What Is The Cost Structure In The Business Model Canvas?

The Business Model Canvas cost structure describes the costs that business occurs through its operations. These include employees, infrastructure, costs associated with all activities as well as sourcing through key partnerships.

Business Model Cost Structure

The Cost Structure of the Business Model Canvas

The cost structure building block presents all the costs that you incur as a business. 90% of new businesses fail in the first 3 years because they fail to understand their costs or what it will take to create the goods and services they have promised in their value propositions.

In another study, CB Insights looked at the post-mortems of 101 startups to compile a list of the Top 20 Reasons Startups Fail. The number two position ‘ran out of cash’.

When reviewing the cost structure block you need to recognise where your main costs will be:

• Key Activities
• Key Partnerships
• Customer Relationships
• Channels

Key Questions To Ask

When doing an analysis of your business model, it is vital to ask the following questions when filling in the Cost Structure building block of the business model canvas:

1. What are the fundamental costs derived from my business model?
2. Which Key Resources represent a significant expense to the business?
3. Which Key Activities represent a significant expense to the business?
4. How do your Key activities drive costs?
5. Are the above-mentioned activities matched to the Value Propositions for your business?
6. By exploring different permutations of your business model, do the costs remain fixed or become variable?
7. Is your business more values-driven or cost-driven?

What Are The Different Types Of Cost Structure?

Cost-Driven

This kind of approach concentrates on reducing costs as much as possible. This can be done through outsourcing and automating wherever possible.

Examples include:

• Aldi
• RyanAir

Value Driven

This is a more value centred approach which focuses on maximising worth for the customer. This approach focuses on a highly personalised and tailored service that really focuses on minimising Customer Pains and increasing their Gains.

Examples include:

• McKinsey
• BBDO

Characteristics of Cost Structures

How costs work depends on their characteristics. It’s important to appreciate the difference between fixed costs, variable costs and ultimately being able to calculate your break-even point.

Fixed Costs

These costs are usually a fixed percentage of your overall costs. While they do change, often incrementally they remain fairly staple.

Examples include:

• Amortization. This is the gradual charging to expense of the cost of an intangible asset (such as a purchased patent) over the useful life of the asset.
• Depreciation. This is the gradual charging to expense of the cost of a tangible asset (such as production equipment) over the useful life of the asset.
• Insurance. This is a periodic charge under an insurance contract.
• Interest expense. This is the cost of funds loaned to a business by a lender. This is only a fixed cost if a fixed interest rate was incorporated into the loan agreement.
• Property taxes. This is a tax charged to a business by the local government, which is based on the cost of its assets.
• Rent. This is a periodic charge for the use of real estate owned by a landlord.
• Salaries. This is a fixed compensation amount paid to employees, irrespective of their hours worked.
• Utilities. This is the cost of electricity, gas, phones, and so forth. This cost has a variable element, but is largely fixed.

Variable Costs

These types of costs change depending on the number of goods and services produced by a business. These include things like raw materials, shipping costs web hosting servers.

Here are a number of examples of variable costs, all in a production setting:

• Direct materials. The most purely variable cost of all, these are the raw materials that go into a product.
• Commissions/Affiliate payments. A commission is an additional compensation a company gives to its employees. Employees may receive commissions for exceeding their expectations and meeting the company’s requirements. Most companies give sales commissions at a rate predetermined in a contract agreement.
• Shipping Costs. Shipping costs refer to the expenses incurred when a company moves its products and raw materials from one point to another. This can be through water channels, roads, air or railways. Shipping costs are variable in the sense that they tend to change with the production and sales volume.

Economies of Scale

Economies of Scope are savings generated when the cost of producing a range of products together is cheaper than manufacturing them individually. For example, several products may share the same marketing activities or Distribution Channels.

One of the advantages of big organizations is that they benefit from the fall in costs with higher volumes which spread fixed costs more thinly making the cost per unit fall dramatically; hence the average cost per unit is reduced. As a result, a bigger company will have a lower cost per unit output than a smaller company. An example is when a big company buys and gets a much lower cost than a small business.

Economies of Scope

Economies of scope refer to the reduction of costs when a business invests in multiple markets or a larger scope of operations. The average cost of production decreases if a company opts to increase the number of goods it produces.

Economies of scope based on product diversification are only achieved if the different products have common processes or share the use of some resource. Hence spending on marketing the products or distribution channels may lessen per unit if both products require similar marketing efforts or use the same distribution channel.

Economies of scope have multiple advantages for the business:

1. A great deal of flexibility in the design and mix of the product
2. Increased response rate and decreased response time to market-driven changes
3. Processes are repeatable with a higher degree of control over their execution
4. Costs are reduced because wastage is minimized in this particular business model
5. Organizations can more accurately predict changes and cycles
6. Software and hardware utilized more efficiently
7. There is less risk associated with a company which sells multiple products, or targets multiple markets or does both. Even if one product or market falters, the company will have alternatives to help tide it over while it readjusts strategy.

Contingency Costs

A common mistake is to underestimate the day to day expenses or odd things that crop up that you haven’t thought about. These might be legal costs e.g. filing patents…it could be anything. The fact is that most entrepreneurs under-estimate daily expenses as well.

The solution is to allow for an overall contingency percentage in your budgeting. A typical figure of ten per cent will suffice until you do the detailed budget planning.

How To Do Some Research On Cost Structurecos

Within a market that has a dominant business model companies often have similar partners, activities and costs associated with sales and marketing. By looking at their publicly available reports you can get a good sense of what costs they incur as well as the costs associated with sales and marketing.

Another benefit of this is to use this information to then consider how you can change the business model, change the cost structure and therefore produce a more sustainable competitive advantage.

Doing your research will eliminate the risks and help to produce a successful business model design.

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2023 essential digital marketing tools

 As marketers today, we’re fortunate to have a huge number of free and low-cost digital marketing tools to give us insight into our customers, competitors, and markets.

These strategic digital tools help us to compete to win and retain customers by delivering automated relevant, real-time marketing communications, integrated across digital devices and traditional marketing channels.

To help highlight the range of great options available, our updated 2023 essential digital marketing tools infographic recommends 30 categories of marketing technology and our pick of the most popular 5 in each category.

Plus, we’ve grouped them across our RACE Growth System for managing digital marketing, so you can review where you could make better use of the tools across the customer lifecycle. Click on the infographic below to see a larger version or download our guide on Essential Digital Marketing tools available to free members to learn more about how and why we created it and how to use it.

What inspired us to create this infographic and guide for digital marketing tools?

We use many types of digital marketing services and insights tools to run and improve SmartInsights.com and because of this, we love to try out new tools when they are suggested to us.

We were inspired by Scott Brinker’s Marketing Technology landscape which does an excellent job of defining different types of ‘enterprise’ tools for managing digital marketing, but can be difficult to read because of the sheer number of tools. There are nearly 10,000 is the latest edition...!

Also, we wanted to include more low-cost and free ‘hands-on’ insight tools which are important for managing activities like search, social media, and conversion rate optimization. These don’t tend to be included on Scott’s landscape.

We also wanted to highlight the most popular, well-regarded services, and give an indication of how they can be used to add value. Business Pro Members can also read our full recommendations in our updated marketing technology selection guide.

How to prioritize marketing insight and management tools?

If you were doubting the number of tools available, just look at the growth in the number of marketing technology applications over the last few years.

To further complicate the landscape, we've recently seen new challenger tools doing a better job than established tools, due to their innovative nature.

The sheer number of tools, which vary enormously in cost and quality, means it's a challenge to keep on top of the latest developments in MarTech. It can be hard to select and manage digital marketing tools, and track their contribution to your marketing results.

To help, our infographic breaks down these essential digital marketing tools into different categories of use and shows you which products you should be considering for different marketing activities across our RACE Growth System.

Optimize your digital marketing strategy

If you're interested in learning more about the differences between individual tools, and how they can help your business then you'll want to download our marketing technology selection guide, for Business Pro Members. Our popular guide contains reviews and information on key features for all of the tools on the infographic, that's 150 tools in total!

Plus, if you're looking to inform and optimize your digital marketing with the latest data-driven techniques, don't miss our RACE Growth System free template to quickly build your RACE digital marketing strategy and improve your performance.

By Dave Chaffey

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Event Marketing in 2023: Trends and Challenges

 Most marketers who organize and run events expect event marketing budgets to increase this year, according to recent research from Splash.

The report was based on data from a survey conducted in November 2022 among 670 event professionals in the United States and Europe.

Some 73% of respondents say they expect event marketing budgets to increase in 2023.

Event marketers say the biggest key to event success in 2023 is attracting the right attendees (32% cite).

Some 43% of event professionals say they expect to run a mix of in-person and virtual events this year and 30% expect to run only in-person events.

Event marketers say their biggest challenges are not enough team members (26% cite as a big issue) and not enough budget (23%).

About the research: The report was based on data from a survey conducted in November 2022 among 670 event professionals in the United States and Europe.

Создание среды улучшения процессов

 То, о чем я буду говорить, не претендует на какую-то научную новизну и не имеет статус открытия. Хотя... На мой взгляд, слово «открытие» здесь весьма уместно, в контексте выражения «открыть глаза», и чуть иначе, а может быть более комплексно, посмотреть на вещи, которые так хорошо известны большинству читателей.

Речь пойдет не столько о сущности преобразований, о превосходстве тех или иных подходов, о способах приложения сил в деле улучшений бизнес-процессов, сколько о мотивах, побуждающих те самые силы совершать непрерывное движение вперед не теряя с таким трудом отвоеванных позиций.

Всем хорошо известно, что на сегодняшний день при внедрении различных методик улучшения господствует, так называемый, инструментальный подход. Что я имею в виду?

Многочисленные книги повествуют нам о столь же многочисленных методиках улучшения. Каждая из методик, обладая глубокой философской основой, признаваемой большинством менеджеров, тем не менее, откладывается в их умах в виде некоторой схемы, алгоритма, или набора прикладных инструментов. Итак, что на слуху?

Бережливое производство (Lean Production). Шаги: определить ценность – описать поток – выровнять поток (добиться непрерывности) – настроить вытягивание – запустить непрерывные улучшения. Кстати, даже на таком уровне бережливое производство понимают далеко не все. Обычно, если спросить – что такое бережливое производство, последует ответ: «устранение потерь, 5S, TPM, Канбан, и т.п. инструменты решения конкретных проблем». Далеко не все вспомнят о потоке, как основной идее повышения эффективности производства.

Всеобщее управление качеством (Total Quality Management - TQM) с соответствующими стандартами систем менеджмента качества - СМК. Шаги: описать процессы и их взаимодействие – определить показатели результативности – определить методологию коррекции-предупреждения, запустить цикл непрерывных улучшений – PDCA. Да, в рамках стандартов есть еще много сопутствующей атрибутики, вроде документированных процедур, руководств по качеству, которые лишь добавляют инструментальной составляющей, размазывая основную идею тонким и незаметным слоем масла по толстому батону требований и предписаний, в которых начинают путаться и сами специалисты СМК.

Теория ограничений (Theory of Constraints - TOC). Что тут: найти ограничение – максимально его использовать – подчинить деятельность системы ограничению – снять ограничение – вернуться к начальному шагу. Ну, конечно, хорошим плюсом тут идут мощные инструментальные довески в виде, скажем, DBR или буферов времени или, что уже сложнее для понимания, грозовых туч с деревьями различной реальности.

6-сигм. Цикл DMAIC. Определить измеряемые показатели – научиться их корректно измерять – использовать математический аппарат для анализа и поиска причин соответствующего поведения – улучшить поведение анализируемой величины, путем устранения причин проблем – выполнить контроль правильности предпринятых мер. И, опять же до кучи, мощнейший аппарат статистического анализа процессов вкупе с диаграммой Исикавы.

Все это и есть та методологическая основа, которая понятна и лежит на поверхности литературных источников. Между тем, если копнуть чуть глубже, то любой улучшенец не преминет дополнить красочной философской основой каждую из обозначенных выше методик.

Бережливое производство? Ни что иное как философия устранения потерь, в основе которой лежит уважение к человеку. Какая потеря самая важная? Конечно же, восьмая! Самое страшное - это потеря творческого потенциала и равнодушие, которые сведут все улучшения на нет!

Всеобщее управление качеством? Без вовлеченности персонала и ответственности руководства нечего и пытаться! Система предложений по улучшению – обязательно!

ТОС. Тут сложнее. В понимании многих ТОС – это поиск ограничений в производственном потоке. Не все понимают, что реальные ограничения системы могут находиться, например, в проблемах взаимодействия между подразделениями, искажении информации или, скажем, в системе оплаты труда. И Голдратт сам в этом виноват! Потому что написав «Цель», он невольно заставил читателей опуститься на уровень производственных реалий, из которых большинство из них и так не вылезает. А тут пожалуйста - новый и такой понятный инструментарий. А речь-то, оказывается идет, прежде всего, о системном представлении организации, о поиске ограничения системы, которое, оказывается, не всегда находится в производстве!

И т.д... Невооруженным глазом видно и многими на подсознательном уровне понимаемо, что существует пропасть между целостным знанием философии улучшений, на которую опирается та или иная методика и тем путем, которым происходит ее реализация.

Без труда можно назвать несколько причин, по которым так происходит.

1. Делаем то, что можем, то, что в наших силах, то, что измеримо и понятно руководству. Например, 5S, TPM, или Канбан.

2. Ощущаем, что реализация философского базиса потребует серьезных изменений. Страшно потерять то, что имеем.

3. Не верим, что так, как получилось в Японии, подходит для отечественного менталитета. Вы эти рожи видели?

Есть и другой подход, который в последнее время все чаще на слуху и который ставят в противоположность инструментальному подходу. Это подход «от проблем».

От последователей этого подхода можно часто услышать: «Не надо внедрять бережливое производство, используйте его для решения ваших реальных проблем»! Или: «Мы не внедряем бережливое производство, мы строим свою производственную систему». Исходная посылка вроде бы правильная и вроде бы даже системная. В самом деле, определить больные точки, определить цели, куда-то их там декомпозировать, и начать планомерно улучшать свое предприятие, прислушиваясь к его потребностям, реагируя на проблемы. Но у нас ведь все по-особому!

Как мы выбираем цели. На верхнем уровне что-то вроде «Современное высокотехнологичное, лидер рынка, европейский уровень, и т.п.». А на уровне участков это выливается в премию, накрученную, ну разумеется, на сделку, и выплачиваемую, например, за 5S, за выполнение плана, за отказ от курения, за стаж и т.п., да бесконечные рейды «лидеров перемен», вынужденных ну хоть административными мерами подпирать шаткую конструкцию гордо называемую Производственной системой.

Как завороженные мы смотрим на происходящее, поначалу даже разделяя энтузиазм засучивших рукава лин-менеджеров, и пытаясь хотя бы в далеком будущем разглядеть очертания «Культуры производства», «Европейского уровня» и утешая себя надеждой на не столь быстрый возврат инвестиций, вложенных в развитие этой самой Производственной системы. А время идет. Энтузиазм сменяется требовательностью, в ответ на которую те же лин-бедолаги вынуждены показывать результат. Вот и появляются всем известные «было-стало», «уголки бережливого производства» и тому подобные «кайдзен-системы», на которых развитие переходит в фазу перманентного пинкообразного движения. А планерки как проходили с руганью, так и проходят… А работники, как бросали тележки в проходах, так и бросают…

А между тем, и все про это слышали, есть такие потери как потери творческого потенциала. А это значит, что есть такой потенциал. И все слышали полумифическую историю про дворника на Toyota, который подметая, выпускает самые лучшие автомобили. И тут мы стараемся не отстать, придумывая различные схемы вовлечения, мотивации, стимулирования. Предложения по улучшению. Бонусы за чистоту рабочих мест, аттестация на знание видов потерь, отчеты для анализа руководства! Что еще нужно то? Ан нет! Невольно на ум приходят слова Жванецкого: «Может надо в консерватории что-то подправить»?

Миниатюра Михаила Жванецкого "Консерватория".

 

Консерватория, аспирантура, мошенничество, афера, суд, Сибирь.

Консерватория, частные уроки, еще одни частные уроки, зубные протезы, золото, мебель, суд, Сибирь.

Консерватория, концертмейстерство, торговый техникум, зав. производством, икра, крабы, валюта, золото, суд, Сибирь.

Может, что-то в консерватории подправить?

Взято с сайта автора.

Что делаем не так? Вот берем те же принципы СМК.

– Управляем на основе фактов? – А как же! Вот таблицы, вот графики!

– Процессы нормально? А то! Все описано и контролируется. Вот документы!

– Персонал? – Вовлечен! Предложения оплачиваются. Вот положение, вот ящик!

– Руководство? Данные предоставляются регулярно. Вот отчет с подписями директора об ознакомлении!

–…

Результат? Кроме как сертификат СМК показать нечего! Брак, незавершенка, поломки, мат на собраниях...

А между тем, что называется, спрос рождает предложение. И феноменальные неудачи, постигающие не только отечественные, да и зарубежные команды улучшенцев, находят свое отражение в литературных источниках, вместе с попытками объяснения их причин.

Я бы хотел отметить две книги, которые, принесли мне значительную пользу, подкрепив фактами ту мыслительную биомассу, которая была рождена размышлениями, подобными приведенным. Первая книга, это Стивен Спир «Догнать зайца», а вторая - книга коллектива авторов (Раджендра Сисодиа, Дэвид Вольф, Джагдиш Шет) под названием «Фирмы несущие любовь». Именно эти две книги в значительной степени подкрепили мои мысли об информационной («Догнать зайца») и культурной («Фирмы, несущие любовь») составляющих любого процесса преобразований.

В основе процессной среды компаний, которые Спир называет Великими, лежат несколько принципов, так не характерных для нашей производственной действительности. Среди них: принцип свободного распространения информации на всех уровнях управленческой иерархии, принцип развития персонала и принцип лидерства через коучинг руководителей. У него в книге почти не встречается упоминания технической стороны вопроса (5Sи т.п.). На первое место он ставит информационную среду.

Авторы второй книги копнули еще глубже. Если Спир говорит о великих компаниях – лидерах современного рынка, об их способности обучаться, реагировать на изменяющуюся обстановку, то здесь речь идет о культурном потенциале, развитие которого позволяет совершить еще более кардинальный скачок в совершенствовании организации. Речь идет о так называем управлении интересами всех, без исключения, участников бизнеса (собственники, клиенты, поставщики, работники, менеджеры) на основе взаимного уважения и доверия. Это даже нельзя назвать термином управление. Скорее это сотрудничество на основе вечных человеческих ценностей: открытости, уважения, дружбы. Ведь именно на эти ценности сейчас так велик спрос, когда человечество буквально оказалось духовно-парализованным товарно-денежными отношениями.

Позволю себе привести несколько ассоциаций. Что бы ударила молния необходима не только разность потенциалов между землей и облаками, но и соответствующая проницаемость среды. Что бы забить гвоздь в стену важна не только масса молотка и сила удара, но и свойства материала стены. И наконец, чтобы вырос росток необходимо не только семечко брошенное в землю, но и полив и солнечный свет.

А ведь с производством также. Мало одного желания и знания инструментов. Необходима подготовленная среда. Среда, в которой будут использоваться эти инструменты. Среда, многократно усиливающая эффект от прилагаемых усилий.

По сути, получается, что есть две координаты, показывающие способность предприятия изменяться и характеризующие его как социальную систему. Эти координаты описывают неразрывно связанные контент и контекст преобразований. Описывают их суть и среду, их содержание и форму.

Применительно к вопросу улучшений это означает, что среда должна быть подготовлена к изменениям, равно как и изменения должны соответствовать уровню среды.

То, что мы видим обычно, есть ни что иное как попытки движения вдоль горизонтальной координаты. Фактически, это означает неудержимое желание улучшать процессы не создавая благоприятной среды для их протекания. Как завороженные мы смотрим на магическую пропорцию Деминга, который указал, что в проблемах виноваты плохо организованные процессы, но забываем, о тех путях их улучшения, которые он же и обозначил: обучение, искоренение страха, устранение норм, и т.п. А ведь именно в принципах Деминга заложено движение по обеим координатам, обозначенной плоскости.

Теперь к вопросу о цели. Если совершенство процессов еще как-то укладывается у нас в голове (спасибо лин, TQM и TOC), то как быть с совершенством отношений? Что понимать под этим?

За последние несколько лет я провел очень много бесед с работниками, в попытках выяснить - в какой же среде работник (да и любой член коллектива: от рабочего до топ-менеджера) будет наиболее эффективен? В конечном итоге ответ, как мне кажется, я нашел. И нашел такой ответ, который мне понравился самому. Однако, как это ни странно, этот ответ не был ограничен лишь рамками производственной системы.

Вот какая штука, я, как и любой человек хочу быть счастлив. Я хочу заниматься любимым делом. С удовольствием просыпаться и идти на работу. Хочу получать достойную зарплату. Хочу общаться с теми, с кем мне приятно. Хочу чувствовать себя в безопасности, возвращаясь домой с заработанными деньгами. Не этого ли хотят все окружающие меня люди? Не этому ли должна быть подчинена та самая среда, которая формирует мое отношение к работе, и, в конечном итоге, определяет эффективность производства.

На прошлом «Лин без галстуков - 2012» я говорил, что естественный путь сделать предприятие эффективным в плане любых преобразований состоит в дуальной парадигме взаимного удовлетворения потребностей предприятия и работников. Фактически, основной тезис моего тогдашнего доклада, с которым можно ознакомиться в заметке «Идеальное предприятие: утопия или цель?», заключался  в том, что если мы хотим, чтобы работники решали проблемы предприятия, то предприятие должно быть нацелено на решение проблем работников, ибо работник принадлежит не только системе «Предприятие», но и системе «Внешний мир». И не может он, приходя на завод, оставить проблемы этого мира за порогом.

Так родилась целевая точка в этой двумерной системе координат, характеризующая совершенство контента и контекста, совершенство процессов и отношений.

Дальше остается нанести некие промежуточные этапы сбалансированного движения по этой комплексной плоскости, когда каждому шагу по контенту соответствует шаг в контексте. Кстати, именно идея о комплексном пространстве (математический термин) натолкнула на мысль о волнообразной структуре движения вдоль линии устойчивого развития. Каждая волна - это очередной этап улучшений. В каждой волне можно выделить последовательность из 3-х повторяющихся фаз: экономическая, информационная и культурная.

Компле́ксные чи́сла — расширение множества вещественных чисел. Любое комплексное число может быть представлено как формальная сумма x+iy, где x и y — вещественные числа, i — мнимая единица, то есть одно из чисел, удовлетворяющих уравнению i²=−1.

Первоначально идея о необходимости расширения понятия действительного числа возникла в результате формального решения квадратных и кубических уравнений, в которых в формулах для корней уравнения под знаком корня стояло отрицательное число. В дальнейшем возникшая теория функций комплексного переменного нашла применение для решения многих задач во всех областях математики и физики, в частности, в теории чисел, многие задачи которой, касающиеся натуральных чисел, получили решение только с использованием понятия комплексного числа.

Взято с сайта Википедия.

Экономическая фаза. Суть - создание экономической базы (предпосылок для улучшений). С одной стороны (процессная координата), это принятие ряда незамедлительных мер по достижению экономической стабильности и прибыльности предприятия. С другой - создание адекватной системы оплаты труда, соответствующей ожиданиям работников.

Информационная фаза. Суть - создание информационной базы для улучшения процессов и отношений. Для процессов направление улучшений можно охарактеризовать словом «полнота», то есть наличие необходимых и адекватных инструкций, технологических карт, средств передачи информации и т.п. Для среды аналогичным словом можно, на мой взгляд, считать слово «прозрачность», что означает разрушение барьеров между структурными подразделениями, всеобщая информированность о происходящем, обратная связь.

Культурная фаза. Суть - создание побудительных мотивов для запуска механизма непрерывных улучшений. С точки зрения процессной координаты - это кайдзен, PDCA, DMAIC и тому подобные процедуры. С точки зрения отношений - это культура, создающая общность интересов, благоприятную среду для развития людей и взаимовыгодное решение проблем в связке работник-предприятие.

Конечно же для каждой фазы можно выделить свой инструментарий, свои особенности и проблемы, которые придется преодолевать. Это тема отдельных публикаций, к тому же ее наполненность значительно зависит от конкретного предприятия. Но оду мысль хотелось бы зафиксировать в явном виде. Попытка двигаться только по одной координате, или перескочить через очередную фазу, практически обречена. Обречена на такой ход преобразований, с рассмотрения которого началась данная статья.

Автор: Дмитрий Стукалов

https://cutt.ly/V8rlBd4