Demystifying Variable Costs in Ecommerce
What is a variable cost?
Variable cost refers to expenses that fluctuate directly with changes in production or sales. In ecommerce, variable costs arise from incremental expenses related to producing or selling each additional unit of product. This means that as production or sales volume increases, so do variable costs.
Variable Cost Per Unit
Variable costs per unit can differ depending on a product's material, production process, and shipping and handling costs.
Number of Units Produced
As you produce or sell more units, the total variable costs increase in direct proportion to the number of units produced or sold.
Variable Cost Formula
Total Variable Cost
Total variable cost (TVC) is calculated by multiplying the variable cost per unit by the number of units produced or sold. This formula looks like:
TVC = VC * Q
Where VC = variable cost per unit and Q = number of units produced or sold.
Average Variable Cost
Average variable cost (AVC) is calculated by dividing the total variable cost by the number of units produced or sold. This formula looks like:
AVC = TVC / Q
Total Variable Cost vs. Average Variable Cost
While total variable cost increases as the number of units produced or sold increases, average variable cost decreases as production levels rise. This is because fixed costs - such as rent, salaries, and utility bills - remain constant regardless of production volume. As production volume increases, the fixed cost per unit decreases, resulting in a lower average variable cost.
Variable vs. Fixed Cost
Fixed costs are expenses that remain constant regardless of changes in production or sales volume. Examples of fixed costs in ecommerce include rent, salaries, and utilities.
Variable costs, on the other hand, are incremental expenses related to producing or selling each additional unit of product. Examples of variable costs include raw materials, production equipment, and packaging and shipping costs.
What is the variable cost ratio?
The variable cost ratio (VCR) is the percentage of total revenue attributed to variable costs. To calculate the VCR, divide variable costs by total revenue, and multiply by 100.
VCR = (Variable Costs / Total Revenue) * 100
A high VCR indicates that a significant portion of revenue is being consumed by variable costs, which can make it difficult to achieve profitability.
Variable Cost Examples
Raw materials and inventory costs fluctuate based on production volume, making them a variable cost category.
Expenses related to machinery maintenance, repairs, and upgrades can also vary depending on production volume.
In ecommerce, sales commissions may be a variable cost where vendors are paid based on the number of units sold.
Wages and salaries of employees who are directly involved in production or sales can be considered a variable cost as they may vary based on production volume.
Credit Card Fees
Credit card processing fees often come with a variable percentage of sales, making them a variable cost in ecommerce.
Online Payment Partners
Similar to credit card processing fees, online payment partners often collect fees as a percentage of sales.
Packaging and Shipping Costs
Shipping and handling costs can fluctuate based on the number of units sold and delivery distance, making them a variable cost category.
Expect the Unexpected
It's important to remember that variable costs can be unpredictable and unexpected. Factors such as supply chain disruptions, changes in commodity prices, and changes in shipping fees can all affect variable costs. By understanding how to calculate variable costs and keeping a close eye on them, ecommerce businesses can make informed decisions and stay on the path to profitability.