What is cost structure?

Standard

Cost structure is pretty dorky even compared to the dorky things I usually write about in these posts, but it is something that is good to know about, because (like liquidity) it is key to the success of a business, and yet is often kind of invisible to consumers.

So, what is cost structure? It is all the costs or expenses that a business has.

We all know the saying, “You have to spend money to make money,” and yes, you do. But if you put out more money as costs than you take in as revenues, you are losing money. That is bad, especially over the long term. For a businessperson, it is every bit as important to understand how and where you are spending money as it is to understand how and where you are making money. (This is why most employees of a company will complain about how their bosses are obsessively cheap–costs matter as much as revenues.)

The fact that cost structure is important is the very reason it is often hidden. If you’re a business, you usually can’t effectively conceal the way you make revenues, especially not from competitors who are in the same business as you and know it just as well. As a result, companies will brag about revenues all day long: We’re the biggest K-Pop label by revenues! OMG! Look at us!! And all our great revenues!!! Which are huge!!!!

In contrast, you often can conceal the ways your business has figured out to spend less. If your company is public, you have to report your costs by certain categories, but those categories are pretty broad. How, exactly, you keep your costs so low is something that you can keep quiet about–it can even be a trade secret, and then your competitors may get so desperate that they wind up engaging in illegal corporate espionage to ferret it out!

If you have the same revenues but lower costs than everyone else, then you will always be more profitable and will always be doing better than the competition–mwa-ha-ha-ha!

Screen Shot 2015-12-08 at 3.21.41 PM

We have become rich! Through thrift!

Costs are usually broken into two categories: Fixed costs, which stay the same no matter how much business you are doing, and variable costs, which increase as your business increases.

So, let’s say you run a traditional K-Pop label–indeed, the very label that handles A Large Group of Attractive People. Plus, you’ve got trainees that you’re hoping to debut one day as A Large Group of Underage Attractive People.

What are your fixed costs?

Office rent, insurance, paying for the dormitory for both groups, feeding both groups, chaperones for both groups, any regular and routine maintenance for the members (training, dermatology, plastic surgery) that is unrelated to any specific revenue-generating activity.

Note that you can alter your fixed costs–they’re not “fixed” in the sense of being unchangeable. For example, you could cut your fixed costs by shit-canning all the A Large Group of Underage Attractive People trainees. But fixed costs don’t rise or fall depending on how many comebacks or other activities you do.

What are your variable costs?

Production of songs, production of CDs, choreography, videos, costumes for appearances, transportation to appearances, shoots and production for photobooks, etc. These are the costs that increase the more active your groups are. Doing a ton of comebacks? You’d better be ready for a ton of variable costs.

In my post on liquidity, I caused your label a liquidity crisis by jacking up your variable costs. However, you can just as easily have a liquidity crisis caused by your fixed costs–the landlord suddenly doubles the rent on those dormitories, and you don’t have the cash on hand to cover it. High fixed costs mean that you need to either have a lot of money (or credit) on hand, or that your label needs to start making a lot of money ASAP.

Are there any benefits to being in an industry with high fixed costs? Yes. High fixed costs are a great barrier to entry–if your industry is really expensive to get into, few people will try, which means less competition for you! (In fact, one big exception to the rule that companies don’t talk about costs is when they spend an enormous shitload of money doing something. That they are very sure to publicize–ideally where any potential competitors can see it!)

You see the connection between high fixed costs and barriers to entry in this interview Decipher had with Snacky Chan. Chan talks about how it used to be that the only way to promote effectively in the Korean music industry was to be on television. The tricky bit was, the only way to be on television was to spend years paying off producers.

Can’t afford the payola? You can’t afford to be in this industry!

You’ll notice that I categorized bribing television producers as a fixed cost. That’s because even if you, the K-Pop label owner, want only A Large Group of Attractive People to appear on television, you’re still going to have to spend years handing out (cash) gifts to television producers for their birthdays, and their children’s birthdays, and their college roommate’s cousin’s children’s birthdays. . . .

If that’s the case, then why wouldn’t you also debut A Large Group of Underage Attractive People as soon as possible? You’ve already spent the money needed to get any group on your label on television; it will be more profitable if you have more than one group out there generating revenue to offset that fixed cost.

But . . . debuting A Large Group of Underage Attractive People will increase your variable costs. From that point of view, it’s better to hold off on debuting your second group, or not debut it at all.

Which is the right call? It depends. As a business owner, you’re going to have to weigh all the variables, make a decision, and hope that your judgement is correct.

In any case, industries with high fixed costs–think airlines or manufacturers of computer chips–tend to be dominated by large players: You need big revenues to cover those big fixed costs. Industries with low fixed costs tend to be waaaaay more friendly to small businesses and individual entrepreneurs (apps or other software development is a good example–all you need is a computer).

Can an entire industry see its cost structure shift dramatically? Yes. Since we’re being K-Poppy here, let’s do two scenarios!

Scenario #1

You own a business in an industry with high costs. You figure out a way to bring down your cost structure–and your cost structure alone. Significantly.

That’s a very nice position to be in. You’ve still got the (perceived) barriers to entry keeping potential competitors out, you’ve got a consumer base that is used to paying a high price for something, and your existing competitors still have high costs. You can cut your prices juuuuust a little below theirs, and you’re going to be a very profitable operation indeed while they struggle to remain solvent.

Of course you’re going to keep your mouth shut about how you keep costs down–that is key. If you make a big deal about your great new cost structure, customers are going to expect you to pass along the savings–plus they may start viewing your brand as the cheap discount one. In addition, existing competitors will start trying to figure out how to copy your methods, while potential competitors will realize that those barriers to entry into your industry that they thought were so high are maybe not that high after all.

Basically in business, you always want your costs to be low, but you want other people to think that your costs are high. That’s the sweet spot.

Scenario #2

You own a business in an industry with high costs. A new technology comes along that is available to everyone and that allows everyone to to bring down their costs. Significantly.

This is actually a much-less desirable position to be in than Scenario #1, and that’s the situation that digitization has brought to many media companies. Newspapers, for example, had this carefully cultivated network that allowed physical copies to be reliably delivered to people’s doorstep every day. But now everyone just looks on-line for news.

The fixed costs that newspapers had–printing presses, fleets of vans, hundreds of employees–didn’t just vanish overnight: It’s hard to change a business model that quickly (especially when it involves laying off half your staff). Meanwhile, new companies stepped right in, offering advertising-supported on-line news, often at no cost to consumers! You see why newspapers (and record stores, and book stores, and encyclopedia publishers) are having such a hard time these days.

Is there a term for these kinds of outmoded cost structures? Yes, those are called legacy costs.

So, here’s the question: Should the cost structure that comes with owning a traditional K-Pop group–which includes payola for television producers and money spent manufacturing CDs–be considered legacy costs?

I would argue that the answer is no–if you can make that business model work. If you want A Large Group of Attractive People to be a conventional K-Pop group, then it makes a lot of sense to have a cost structure that includes things like sucking up to television producers and manufacturing elaborate CD sets and other expensive merchandise, because that’s how you 1. develop a fan base, and 2. monetize your fan base.

But if that’s not what you want to do, it makes no sense to adopt that cost structure. High fixed costs require high revenues–revenues that are often much higher than what is needed to turn a lovely profit when you have a different cost structure–and generating massive revenues is hardly an easy task.

People sometimes buy into the notion that you have to do Big Company things (selling X many units, having huge marketing campaigns, etc.) if you’re serious about your career and want to be “successful”–a term they define very narrowly indeed. But all that rigamarole could potentially bankrupt you.

If you’re happy putting out digital singles and having your major promotional cost be the T-shirts you sell at concerts, and you can make money doing that, there is absolutely no business reason to cough up for all the rest. Don’t borrow trouble, and don’t try to adopt the wrong cost structure.

Advertisements

18 responses »

  1. Kind of cost-related: I’ve been following the Block B style twitter, and why do you think they wear such expensive designer crap? At least half the things could be replaced by something totally similar at a small fraction of the cost, thus saving everyone money.. One example is the Bottega Veneta booties both Taeil and Zico wear. No, no, and no, when Clarks Desert Boots would be practically the same thing (just not Italian).

    Anyway, it made me wonder if there was a point to all the Italian designer things show because it’s doubtful Gucci, Bottega Veneta, Givenchy and St Laurent are sponsoring them. Our boys are cute, but those brands sponsor people like Choi Siwon and Kris Wu, not Block B.

    • Well, you wear genuine designer things so that people know that you are the sort of person who wears genuine designer things…. P.O complained during “Fashion King” that the only clothes Zico likes are expensive ones–but then again they’ve also said that they raid P.O’s closet for stage clothes. So who knows who’s to blame?

      • I guess if the designer clothes they wear are their own and not part of their debt to the company, then that’s different from the company spending, and then taking it out of their salaries as a cost. They can spend their money as they like.

    • I think that is part of the job also, if you are too frugal with fashion you kind of not that interesting for some types of photographes. If you want nice things to show off as a public person being caught with fake stuff is a scandal. When BTS released the Fire album, no clue the name, they made photos pretty similar with shinee and used big brands but some people said not original pieces and they got dragged for it. Not something wrong, as artist they know how bad is to have people copying your work and taking money from you. So I guess they invest in nice things they like but they pretty much rotate between them a lot, you gonna see lots of stuff one used in a show, another member will use later, specially between Ukwon, Zico, Taeil and PO, somehow I don’t see the other 3 using the same stuff the others do.

      Important thing is, they buy stuff they enjoy wearing and even guys praise a lot their fashion, wich is nice. They are kind of role model of cool guys for lots of men too. Better than SM stylist experiments 😀

      • I agree that it adds to the perception that the group is successful and creative, which is important. (Obviously fakes are a nonstarter, for many reasons–we were talking more about just wearing cheaper brands.) And you definitely see stuff passed around–although I don’t know how thrifty that is these days when they wear $1,300 hoodies! But they obviously like it, and it’s gotten them quite a bit of attention–plus I’m sure a lot of Zico’s modeling gigs come as a result of his unique look and his knowledge of the fashion world!

        • Yep, is important to be trendy too, and as creative people they need to express thru fashion too, is a big thing for their image and probally self steem too, if you gonna be clicked 24/7 you better look cool. But besides that they really have a lot of interest in fashion, seeying that show fashion king was fun cause their ideas are good, wich is why someday I expect to see Zico or maybe PO creating a brand, same as Hongki did. Even with expensive stuff they still pass around, I remember seeying others using that shirt from Though Cookie that was very expensive and even Babylon used fashion they had in his new mv.

          Zico is fashionable a lot, I wish Jaehyo had a more stylish style cause he is perfect for modeling, but his fashion always too simple I think that doesn’t work in his favor. =/

            • Jaehyo is like an unicorn, he is cute and pretty and different. I don’t get him sometimes cause about his looks he aint humble but he doesn’t try to show off as a chic handsome man when he is clicked or even doesn’t try to be seen a lot out of promotions. I see him a lot in his SNS he is very active chating with fans and being friendly online but he needs to do something to himself T_T. I can’t even blame the other members they all praise each other a lot and always say how good looking Jaehyo is. -_- he drives me nuts Him and bbomb are a bit too quiet when not working.
              If I had his looks I would be all handsome going out very well dressed and making women faint 😀

              • I joke about Jaehyo being “cursed” with good looks, but seriously sometimes people’s talents and interests don’t coincide. His looks have made it possible for him to have a career in am extremely competitive field, but I’ve never gotten the sense (even with the bragging) that he’s actually really invested in them–he keeps them up because that’s his job, but otherwise….

              • Me too. If I was that goodlooking in the entertainment industry, I’d be working my appearance every which way I can. That Men’s Health cover is an example: after that cover, Jaehyo should’ve been lapping up the jeans cfs or, at least doing more modeling. But nothing.

  2. Pingback: That’s right! | My Other Blog

  3. Pingback: Thoughts on the Taiwanese market (and others, too) | My Other Blog

  4. Pingback: Freedom: BAD | My Other Blog

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s