What is a Step Fixed Cost?

Step Fixed Cost

A “step fixed cost” refers to a cost that remains constant over a certain range of activity levels, but then changes (usually increases) to a new fixed level when the activity surpasses a specified threshold. These costs remain fixed for a given range of output or activity, but they can change in “steps” as the activity level reaches specific limits.

In other words, unlike traditional fixed costs that remain unchanged regardless of the activity level (at least in the short term), step fixed costs display a series of fixed plateaus, each related to a specific range of activities.

Example of a Step Fixed Cost

Let’s delve into a nuanced example involving a software startup.

Scenario:

Imagine you’re running a software startup that provides online cloud storage solutions. As the number of subscribers to your service grows, you need to invest in server infrastructure to handle the increased data storage and traffic. You have determined that a single server setup can handle up to 10,000 subscribers. Whenever subscribers exceed this count, you will have to set up an additional server.

Cost Structure:

• Cost of maintaining a server (including hardware maintenance, energy, and cooling costs): $5,000/month.
• One-time setup cost for each server: $20,000.

Step Fixed Cost Analysis:

• Up to 10,000 subscribers: You need one server.
  • Monthly cost: $5,000
  • One-time setup cost: $20,000
• 10,001 to 20,000 subscribers: As your subscriber count goes beyond 10,000, you have to set up and maintain an additional server.
  • Monthly cost “steps up” to: $10,000 ($5,000 x 2 servers)
  • Additional one-time setup cost for the new server: $20,000
• 20,001 to 30,000 subscribers: Another jump in server requirement.
  • Monthly cost becomes: $15,000 ($5,000 x 3 servers)
  • Additional one-time setup cost for another server: $20,000

Operational Decisions:

Based on this step fixed cost structure, your startup must make some crucial decisions:

• Pricing Strategy: If you’re nearing the 10,000-subscriber mark, you know that your costs are about to jump significantly. This knowledge might impact how you price your service or any promotional offers you might be considering.
• Budgeting : Knowing these step intervals helps in budgeting, ensuring you have the necessary funds allocated for server setup and maintenance as your subscriber base grows.
• Resource Optimization: If you’re at, say, 10,050 subscribers, you’re slightly over the limit for one server but not fully utilizing the capacity of two servers. This underutilization might prompt you to find ways to optimize server usage or perhaps consider other temporary solutions until subscriber counts justify the additional server cost.

In this example, the step fixed costs are clearly illustrated through the server setup and maintenance costs that remain constant within specific subscriber ranges but jump to a higher level as subscriber counts exceed those ranges.