Cost Structure in Business Models: How Companies Manage Expenses to Maximize Profit
Every business spends money to operate—rent, salaries, materials, marketing, technology, and more. But how companies manage these expenses determines whether they thrive or struggle. Cost structure is the framework of all expenses a business incurs to deliver its product or service.
Understanding cost structure helps you analyze business models, spot competitive advantages, and predict which companies can scale profitably. Whether you're investing, starting a business, or just curious about how companies work, this concept is essential.
💰 What Is Cost Structure?
Cost structure refers to the combination of fixed costs and variable costs that a business must pay to operate. It answers a fundamental question: What does it cost to run this business, and how do those costs change as the business grows?
Some businesses have high upfront costs but low ongoing expenses (think software companies). Others have low initial costs but high per-unit expenses (think food delivery services). The balance between these determines profitability, scalability, and competitive positioning.
Fixed Costs vs. Variable Costs
🏢 Fixed Costs
Definition: Expenses that stay the same regardless of how much you produce or sell.
Examples: Office rent, salaries, software licenses, insurance, equipment depreciation.
Key trait: You pay these even if you sell nothing.
📦 Variable Costs
Definition: Expenses that increase as you produce or sell more.
Examples: Raw materials, shipping fees, transaction fees, commissions, packaging.
Key trait: These grow with every unit sold.
🎬 Netflix: High Fixed Costs, Low Variable Costs
Netflix is a perfect example of a business with high fixed costs and extremely low variable costs. The company spends billions creating and licensing content—these are upfront investments that don't change whether 10 million or 250 million people watch.
💡 How Netflix's Cost Structure Works
Fixed Costs: Content production ($17 billion annually), technology infrastructure, engineering salaries, marketing campaigns.
Variable Costs: Nearly zero—streaming one more episode to one more subscriber costs almost nothing. The content is already created, and server costs scale efficiently.
The advantage: Once Netflix covers its fixed costs, every additional subscriber is nearly pure profit. This is why scaling matters so much—more subscribers = dramatically higher margins.
📊 Real Numbers
In 2023, Netflix spent roughly $17 billion on content but added tens of millions of subscribers without proportionally increasing costs. This cost structure allowed them to generate over $5 billion in operating income.
Compare this to a traditional cable network that must pay for physical infrastructure, local offices, and distribution deals—Netflix's digital model is far more scalable.
🚗 Uber: High Variable Costs, Lower Fixed Costs
Uber operates on the opposite end of the spectrum. Unlike Netflix, Uber's costs grow almost linearly with every ride. The more trips passengers take, the more Uber must pay drivers, process transactions, and handle support requests.
💡 How Uber's Cost Structure Works
Fixed Costs: Technology platform development, corporate salaries, marketing, legal and regulatory compliance.
Variable Costs: Driver payments (70-80% of fare), payment processing fees, insurance per trip, customer support per ride, incentives and promotions.
The challenge: Because Uber doesn't own the cars or employ drivers as traditional employees, they can't easily reduce variable costs. Every ride generates revenue but also triggers substantial expenses.
📊 The Profitability Problem
For years, Uber struggled to become profitable because variable costs ate most of the revenue. In competitive markets, they had to offer driver incentives and rider discounts, further shrinking margins.
Only after achieving massive scale, optimizing routes with algorithms, and reducing promotions did Uber finally reach profitability in 2023. This shows how businesses with high variable costs need extreme scale and efficiency to succeed.
🚙 Tesla: Transforming Cost Structure Through Scale
Tesla's cost structure illustrates how manufacturing businesses can achieve profitability through economies of scale. Early on, producing each electric vehicle was expensive because factories weren't fully utilized, supply chains were immature, and production volumes were low.
💡 How Tesla Reduced Costs Over Time
2018: Tesla lost money on many cars sold because production was inefficient and battery costs were high.
2024: Tesla now produces millions of vehicles annually, spreads fixed costs (factories, R&D) across more units, and negotiates better deals with suppliers.
The result: Cost per vehicle dropped significantly, turning Tesla into one of the most profitable automakers by margin percentage.
📊 Economies of Scale in Action
Tesla's Gigafactories are massive fixed investments—billions spent on facilities. But once operational, producing one more car becomes cheaper because those fixed costs are divided among more vehicles.
Additionally, Tesla vertically integrated battery production, reducing reliance on expensive third-party suppliers. This control over the supply chain lowered variable costs per unit.
Lesson: High upfront costs can lead to competitive advantages if you achieve scale.
☁️ Amazon Web Services (AWS): The Power of Leverage
AWS showcases how leveraging existing infrastructure creates incredible margins. Amazon built massive data centers for its retail business, then realized it could rent out excess computing power to other companies.
💡 How AWS's Cost Structure Creates Dominance
Fixed Costs: Data centers, servers, networking equipment, engineers—these were already built.
Variable Costs: Electricity, cooling, bandwidth—relatively low compared to revenue generated from customers.
The magic: AWS took costs Amazon was already paying and turned them into a revenue stream. Companies like Netflix, Spotify, and Airbnb pay AWS billions to use their servers.
📊 Profit Powerhouse
AWS generates over 60% of Amazon's total operating profit despite being a smaller portion of revenue. Why? Because the infrastructure costs are largely fixed, and each new customer adds high-margin revenue.
This is why Amazon can afford to run its retail business at thin margins—AWS subsidizes everything else.
🎮 Epic Games vs. Traditional Game Studios
Game development offers a clear contrast in cost structures. Traditional studios like Rockstar Games spend years and hundreds of millions developing a single title (GTA, Red Dead Redemption). Once released, variable costs are minimal—digital downloads cost almost nothing.
Epic Games took a different approach with Fortnite—free to play, but monetized through in-game purchases (skins, battle passes). Their cost structure shifted from one-time development to continuous content creation.
💡 Two Different Models
Traditional (GTA V): Huge fixed cost ($265 million to develop), minimal variable costs, one-time purchase revenue. Result: Massive upfront risk, but if successful, extremely profitable.
Live Service (Fortnite): Lower initial development cost, but ongoing expenses for new content, events, servers. Result: Predictable recurring revenue, but constant investment required.
The winner? Fortnite generated over $9 billion in 2018-2019 alone through microtransactions—more than most traditional games earn over their entire lifetime.
🎯 Why Cost Structure Matters for Investors and Entrepreneurs
For Investors: Understanding cost structure helps you identify which companies can scale profitably. Businesses with high fixed costs and low variable costs (like software, streaming) often become more valuable as they grow because margins improve dramatically.
For Entrepreneurs: Your cost structure determines your path to profitability. If you have high variable costs (like Uber), you need massive scale or pricing power. If you have high fixed costs (like Netflix), you need enough volume to cover those investments.
🔍 Questions to Ask
What are the fixed costs? Rent, salaries, equipment, technology—these need to be paid regardless of sales.
What are the variable costs? Materials, shipping, commissions—these grow with every unit sold.
How do costs change with scale? Do margins improve as you grow, or do they stay flat?
Where can costs be optimized? Automation, bulk purchasing, vertical integration—smart businesses constantly reduce expenses.