MARKETING DECISIONS 105
Cost behaviour
Marketing decisions cannot be made in isolation from knowledge of the costs
of the business and the impact that marketing strategy has on operations and
on business profitability. Profitability for marketing decisions is the difference
betweenrevenue– the income earned from the sale of product/services – and cost.
As we saw in Chapter 3, it is the notion of cost that is problematic.
For many business decisions, it is helpful to distinguish between how costs
behave, i.e. whether they are fixed or variable.Fixed costsare those that do not
change with increases in business activity (such as rent). This is not to say that fixed
costs never change (obviously rents do increase in accordance with the terms of a
lease) but there is no connection (except sometimes in large retail sites) between
cost and the volume of activity. By contrast,variable costsdo increase/decrease
in proportion to an increase/decrease in business activity, so that as a business
produces more units of a good or service, the business incurs proportionately
more costs.
For example, advertising is a fixed cost because there is no relationship between
spending on advertising and generating revenue (although we may wish there
was). However, sales commission is a variable cost because the more a business
sells, the more commission it pays out.
A simple example shows the impact of fixed and variable cost behaviour on
total and average cost. XYZ Limited has the capacity to produce between 10,000
and 30,000 units of a product each period. Its fixed costs are £200,000. Variable
costs are £10 per unit. The example is shown in Table 8.1.
In this example, even if the business produces no units, costs are still £200,000
because fixed costs are independent of volume. Total costs increase as the busi-
ness incurs variable costs of £10 for each unit produced. However, the average
costdeclineswiththeincreaseinvolumebecausethefixedcostisspreadover
more units.
Not all costs are quite so easy to separate between fixed and variable. Some
costs are semi-fixed, while others are semi-variable.Semi-fixed costs(also called
step fixed costs) are constant within a particular level of activity, but can increase
when activity reaches a critical level. This can happen, for example, with changes
from a single-shift to a two-shift operation, which requires not only additional
variable costs but additional fixed costs (e.g. extra supervision).Semi-variable
Table 8.1 Cost behaviour – fixed and variable costs
Activity (number of
units sold)
Fixed costs
(£200,000)Variable costs
(£10 per unit)Total cost
(£)Average cost
(per unit)10,000 200,000 100,000 300,000 £30.00
15,000 200,000 150,000 350,000 £23.33
20,000 200,000 200,000 400,000 £20.00
25,000 200,000 250,000 450,000 £18.00
30,000 200,000 300,000 500,000 £16.67