What is Variable Cost?
A variable cost is a corporate expense that changes in proportion to how much a company produces or sells. Variable costs increase or decrease depending on a company’s production or sales volume—they rise as production increases and fall as production decreases.
The total expenses incurred by any business consist of variable and fixed costs. Variable costs are dependent on production output or sales. The variable cost of production is a constant amount per unit produced. As the volume of production and output increases, variable costs will also increase. Conversely, when fewer products are produced, the variable costs associated with production will consequently decrease.
Variable Cost Formula
To calculate variable costs, multiply what it costs to make one unit of your product by the total number of products you’ve created.
Your total variable cost is the sum of all variable costs associated with each individual product you’ve developed. Calculate total variable cost by multiplying the cost to make one unit of your product by the number of products you’ve developed.
Factors to Optimize Variable Costs
The key to maintaining a healthy profit is monitoring your costs. Variable costs, or variable expenses, is how much you spend to produce and sell your products. For example, variable costs may include the costs of raw materials and packaging or shipping and transaction fees which can rise or fall depending on the number of output and sales. This is different from fixed costs that remain constant such as rental fees.
Here is a quick list of factors that contribute to your variable costing and tactics on how you can lower these fees to control your business costs.
1. Promotions and Discounts
Juicy promotion offers are hard to resist. As marketers, we know this very well and are always employing sales promotions to convince potential leads to become buyers. From vouchers to bundles and free shipping, there are many promotional tactics that can give you a surge in traffic and sales. However, this is provided that your promotional pricing strategy still retains profitability. On one hand, if you are offering that worth way more than your gains, you risk suffering sluggish revenue. What you need is a plan that allows your business to benefit from sales promotions just as much as your customers.
An effective promotion strategy to adopt is to use stackable discounts. Here’s an example by Pottery Barn that only opens up more discounts with more purchases. Not only does this tactic encourage your customers to spend more, this also places limits on the customer’s ability to redeem discounts past a certain threshold, ensuring that the profit margin is still maintained.
2. Product Cost and Negotiated Volume Pricing
When it comes to getting more profits, it is a balancing act between your product cost and selling price. The lower your product cost, the better profit margin you can command. In any scenario, product cost refers to the expenses used when creating or acquiring a product. It can involve the cost of labor, raw material, transportation expenses and so on. To increase your Ecommerce profitability, you need to find ways to lower your production cost. Variable cost can be lowered as your production volume increases.
If you are a reseller, do not forget to use your high volume purchase to negotiate for a lower cost unit price. Or if you make your products, look into your production line for efficiency. Check and compare raw materials and manufacturer costs and select the most cost-effective. This should all be taken into consideration when you decide on your pricing and promotion. As long as your price covers your expenses and provides a better profit margin, you can always test and adjust it as you go to find the best profitability.
3. Product Labels, Packaging, and Printing Costs
Packaging and labels isn’t purely a cost. They are also an investment in your brand and have a huge influence in how your customers perceive your products.
First impressions matter. For new users, your label branding and packaging can be the factor that entices them to put your product in their cart. If successful, your packaging is also what they will remember you for. So instead of taking a price-first approach, you need to factor in brand equity and consumer perception into your product labelling design. Ask yourself, what do you want people to feel when they see your product and how can you stand out among your competitors? Use creativity to tell the right packaging story with a cost-effective label.
4. Packing and Fulfillment Costs
As important as it is to sell your products, getting them to the buyers on time is also equally significant. Packing and order fulfillment is a vital part of the Ecommerce’s supply chain. Depending on your product and online channels, you can leverage the fulfillment service offered by each channel or look for external sources that are more cost-effective.
Different order fulfillment services have different pricing models and quality of services. So make sure you are clear on the details before jumping right in. [Text Wrapping Break] Most importantly, make sure to calculate your product fulfillment cost by SKU before you price your product or offer free shipping, otherwise your business expenses can be high.
5. Promotional Acquisition Costs
Your marketing cost is also considered a variable cost as it changes and fluctuates according to sales volume. When adjusting your promotional acquisition costs, it is not about how much you spend but rather the ROI for each of your marketing channels. Basically, this is calculated by dividing all the costs spent on acquiring new customers by the number of new customers acquired during the campaign.
Through CAC, you want to look for the traffic acquisition method that offers the best return of investment and center your marketing campaigns around it.
6. Returns and Refunds
You might be doing well in the marketplace and your Ecommerce store, but still it’s impossible to avoid tricky customers that are looking for a refund. Once a refund happens, this can add costs for processing returns such as transportation and storage. Besides, it can be difficult to repack the product and put it online so you want to avoid this if possible by offering excellent customer service.
Deal with returns and refunds through empathy and try to understand the reasons why your customers are refunding. Inspect your customer experience, fulfillment time, product quality so you could lower and even forecast your cost in a more efficient and manageable way. If any of your products are getting a lot of requests for a refund, check to see if your brand perception matches with the product you are delivering.
Variable Cost vs. Average Variable Cost
Variable cost and average variable cost may sound similar, but each describe an entirely different value of expenses. While variable cost is usually used to describe the variable cost for a single product, average variable cost often analyzes production over time and compares variable costs to what has been produced. Average variable can be calculated as
Due to price increases or rebates, variable cost and average variable cost may not always be equal. Think about the variable costs associated with a long-term project. Hourly pay for an employee is a variable cost; nevertheless, that employee received a promotion last year. The current variable cost will be higher than it was previously, while the average variable cost will stay somewhere in the middle.
Final Thoughts
Every company incurs two types of costs: variable and fixed costs. Unlike fixed costs, which do not change per each unit of production, variable costs are related directly related to each product a company produces or service it delivers. Should you have any questions regarding the Variable Costs and Fixed Costs or are looking for expertise to bring your Ecommerce business to the next level, feel free to reach out to our team at to our team at contact@commerceplus.asia or get in touch to learn more.