Four Cs

Lots of things come in “fours": The Wiggles. The horsemen of the apocalypse. And stooges. Yeah...don’t forget Shemp.

Ok...so on to practical reality, concepts that actually…matter. Think about your personal budget. The one you use to direct your day-to-day expenses. Everyone knows there are four universally accepted types of costs: rent, Internet, burritos, and video games. Now, think about a company. As with your budget, there are four types of costs that a company has to consider. The categories are slightly different, though.

Generally speaking, a business has to keep in mind these four kinds of expenses: fixed, variable, semi-variable, and step. The categories correspond to how much the cost changes when the amount of output changes. You increase the amount of stuff you make. How much did the cost change? Not at all? That’s fixed. The cost changes proportionally with every increase in production? That’s variable.

Somewhere in-between? That situation can fall into either the semi-variable or step camps.

You own a factory that makes toothpicks for gap-toothed people, made from exotic hardwoods. It’s called the DunawayLettermanJackolantern Company. Tough to fit on a mug, but…you like it. You make 100,000 boxes of toothpicks a month and want to ratchet that number to 120,000 boxes. A 20 percent bump. How will the increased production affect costs?

Well, the actual costs will respond differently. It depends on what category they fit into. Will all of the costs go up 20 percent with this increase in production? Eh, probably not. So…a quick tour: Fixed costs don't change at all. They stay the same, no matter how much you make. Fixed. Like the toothpick grinding floor, the sawdust sucking system, the factory building itself. 50,000 units. 80,000 units. 100,000 units. Fixed cost is the same.

The only big, notable difference is that the fixed cost of the factory is now amortized over a larger number. That is, say it costs 20 grand a month to rent that factory and all the equipment in it; if you made 20 thousand toothpick boxes a month, the fixed cost per box would be a grand; if you made 200,000 toothpick boxes a month, the fixed cost per box would be a hundred bucks.

So that's fixed. It doesn't change month after month after month as it...recurs. Variable costs are directly linked to the amount of output the factory is making, and variable…um...varies. The increase in cost here is proportional. Make one more toothpick and the variable costs increase accordingly. Why? Because you have to buy more raw wood supplies to put through the system. You have to run the saws longer. You have more sawdust to clean, more packing material to buy, etc, etc.

More output demands more input, so think: high bran fiber food. Something like that.

Ok…next: Semi-variable costs have elements of fixed costs and elements of variable costs. Usually, they have a fixed component and a variable component. The electricity to run the machine that puts the little plastic floofy things at the end of the toothpicks. Turning it on takes a certain amount of baseline electricity. That part is fixed. But then...running the machine takes a little extra electricity for each floofy thing that gets installed. That part is variable. The cost of running the machine gets thrown into the semi-variable group, a little bit fixed, a little bit variable.

The last category is step costs. These increase in levels. The increase isn't proportional, as with variable costs, but instead takes place in steps. Step costs might stay the same when output rises from 100,000 to 120,000...but then a 120,001st item causes the step cost to bump up. The cost jumps up in chunks...stays the same for a while, but at a certain point moves to a higher level. Then stays the same for awhile, until it reaches a certain production point.