What are different types of costs for an internet company?
After differentiating between the two levels of revenue, let's move over to understanding the different levels of costs.
In the context of an internet company, costs are typically classified into various buckets based on their behavior and relation to business activities. These categories include Cost of Goods/Services, Variable & semi-variable Costs, and Fixed Costs.
Types of Costs:
1. Cost of Goods/Services Sold (COGS): production cost that is incurred by the business. This is the first level of cost that is deducted from net revenue.
This deduction would give you the corresponding first level of margin i.e. Gross Margin (GM)
2. Variable & Semi-variable Costs: costs that are not production costs but similarly increase depending on the number of transactions e.g. shipping charges, marketing costs, etc.
Deducting this bucket of costs gives you the next level of margin: Contribution Margin (CM)
However, these costs are varied, and are, therefore, further classified into 3 different sub-levels:
i. Direct costs such as labour costs, Shipping costs, Payment Gateway charges, etc., that scale almost always linearly with volume of transactions.
Deducting these from Gross Margin gives you Contribution Margin 1 (CM1).
ii. Marketing Costs: While these also increase with scale, but the increase is not linear.
Deducting marketing spends from CM1 gives you Contribution Margin 2 (CM2).
iii. Content Costs, Software Costs, etc., that have some fixed costs, but scale beyond a certain level.
Deducting these costs from CM2 gives you Contribution Margin 3 (CM3).
3. Fixed Costs: These are costs that remain constant regardless of the volume of goods or services produced or sold.
Examples include rent for office space, salaries of permanent staff.
Deducting these costs from CM gives you Operating Margin.
Next steps:
This might be too much of a breakdown to grasp at once. But do not worry as we will be covering these different levels of costs and the corresponding levels of margins individually again, in the subsequent concept cards.
We will also cover their respective significance and remedial measures.