Have you ever worked with an artisan who came saying, “prices have changed”? Did they forget to add the item(s), or did they not? It can often seem that these artisans are trying to scam you. They keep coming back for more. [money]. They may have been honest about their needs, but they had done a poor cost analysis that led to a cost trap.
Unlike artisans, it’s near impossible for most businesses to renegotiate pricing once the deal is sealed.
What is a Cost Trap?
A Cost trapThis is when a business fails to reduce its business costs and loses money. This means that a business can fall into a cost trap if the cost of providing a service or producing goods exceeds its revenue.
It is important to identify the intended target market and the price they will pay to avoid falling into a cost trap. Knowing the costs involved in developing an idea into viable offerings is essential.
Two types of costs must be considered when developing an idea for a scalable company:
These are costs incurred in the creation of a new company.
Different businesses have different upfront costs. These are typically one-time costs for research and development that create new products or services.
Other typical upfront costs include insurance, license, permit, professional/consultation fees, and technology (gadgets or software) costs.
These are your daily operating expenses.
Finance specialists might disagree.
Typical running costs may include rent, utilities (power, water), overhead, repairs and maintenance, professional/consultation fees, advertising/promotion, etc.
While upfront costs can be recovered, operating expenses can cause burnout and trap cash.
Kolibri’s 2021 business was shut down due to the fact that the market for the services was willingly paying 25% more than the actual cost.
Similarly, wellness startup, Arivale was created to change preventative health care, only to bankrupt a few years later because it couldn’t find a viable price point for its services.
There are many strategies that can be used to solve or avoid cost traps. This article will discuss three strategies to help your business scale quickly at a very low cost.
Economies of Scale
Economies are a reduction in costs that is proportional to the increase in production.
This is an ability Elon Musk excels with in all of his businesses. Tesla’s massive success can be traced to the economies of scale of its two most important components: batteries and solar power generation cells, both of which are manufactured significantly cheaper in higher numbers.
Also, everything at Tesla is geared toward increasing the efficiency of “the machine that makes the machines,”.
If you’ve ever branded items, you can testify that the more quantity you brand, the cheaper the cost of branding per piece. Producing large quantities in low-cost units is simply a matter of economies of scale.
While labour arbitrage may not be used daily, most businesses employ it.
Experts limit labour arbitrage to the transfer of work to different locations with the same skill set, but at lower prices.
Others use a wider definition of labour arbitrage, which includes multiple corporate policies that result is the lowest-cost labour. Your business can leverage this strategy to create models that don’t rely on top-tier talent.
Finding and paying high wages for labour becomes prohibitive as your business grows. It is possible to offer clients services that provide their full value, even if you have to pay average labour to deliver them.
A common form is paying per project, other forms include the use of off-shore workers, where companies can hire workers in a foreign country and pay lower labour costs, and the use of cheaper subcontractors or contract staff in a company’s home country instead of full-time staff/employees.
Outsourcing helps startups execute faster because outsourcing providers already have everything in place to get the job done – people, processes, and technology. This increases efficiency and improves customer experience.
These questions can be answered once you’re able to: Do I prefer this to be done in-house, or offshore?? Which option allows you to grow and work more efficiently?? What can I lose or gain?? You are on the right track to success.
Google, which outsourced more employees than it employed in 2019, is one example of an outsourcing use case. Microsoft is expected to have similar numbers from both sides. Slack, Skype and Opera are just a few of the companies that have had significant success with outsourcing as startups.
Marketing, sales, human resources management, accounting services and strategic communications are all common outsourced business units.
Because they all use some of the same strategies, scaleable businesses look similar. However, every unscalable business is not scalable.
The key to success is being able to anticipate and then avoid possible problems.