Structure in profitability case

Question

As a novice I kind of struggle with structuring the cost branch of my issue tree. If the interviewer has no prefered segmentation, Victor Cheng and the Preplounge tutorial recommend to structure costs into "costs/unit" and then into "fixed costs/unit" and "variable costs/unit". However, segmenting costs directly into "costs/unit" sounds kind of peculiar to me due to the counteracting forces of this equation: if from one year to the other, a company sells more "units" (assuming "variable costs/unit" stay the same, and total fixed costs did not change), the new "costs per units" will be less as "fixed costs/units" have gone down. Thus, its not really MECE as "units" affects the "costs/units" via "fixed costs/units".
I'm kind of confused by this cost segmentation and how it should help me to identify root causes of profitability problems. Can anyone recommend a good way to segment costs if nothing is given by the interviewer?

Thanks!

Answer 1

In this case, fixed & variable costs are MECE for the reasons below.

Fixed costs are costs incurred by the business whether they produce 0units or 1million units. Yes, the more units they create, then logically fixed costs can be distributed among the units made but this is wrong thinking. We pay for salaries, rent, utilities: such fixed costs the business needs to incur before any unit is made.

Variable costs are costs that are DIRECTLY attributed to the making of the unit (material, labour,distribution etc) and therefore it is better to look at variable costs on a per unit basis.

If you do the chewing gum case, you will get 1 table full of costs. Indirect costs are therefore identified as your fixed costs.

You can look at both fixed/variable costs on a unit or total basis, but it all depends on the case, the business structure and what is being sold as this will dictate (per/unit or total) which methodology you use.

I hope this helps.

Answer 2

Hi!

I usually recommend structuring the costs into Fixed and Variable costs. Then you can structure separately the Variable costs as variable costs per unit and the number of units.

Best!