Step Variable Cost
A step variable cost is a cost that behaves like a variable cost over a certain range of activity but then jumps to a new level once the activity exceeds a certain threshold. Unlike traditional variable costs that change proportionally with the level of activity, step variable costs remain constant over specific intervals and then suddenly change to a new level.
These costs are variable in the sense that they can change with the level of activity, but they do so in “steps” rather than in a continuous linear manner.
Example of a Step Variable Cost
Let’s use a catering business as an example to illustrate the concept of step variable costs.
You own a catering business that specializes in events. Due to the nature of your business and to maintain quality, each of your chefs can only handle catering for up to 50 guests. If an event has more than 50 guests, you’ll need to bring in another chef.
- Fee for each chef: $500 per event.
- Each chef caters up to 50 guests.
Step Variable Cost Analysis:
- Event with 1 to 50 guests: You need only one chef.
- Cost: $500
- Event with 51 to 100 guests: The guest count exceeds one chef’s capacity, so you’ll need two chefs.
- Cost “steps up” to: $1,000 (2 chefs x $500 each)
- Event with 101 to 150 guests: The requirement goes up to three chefs.
- Cost becomes: $1,500 (3 chefs x $500 each)
And so on…
- Scenario A: You’re approached for an event with 45 guests. Here, your cost would be $500 for one chef.
- Scenario B: Another client wants catering for 55 guests. This small increase in guest number results in a significant cost jump, as you’ll now need two chefs, making the cost $1,000.
- Scenario C: A large event is planned with 145 guests. For this, you’d need three chefs, and the cost would be $1,500.
This example showcases how a slight change in the activity level (number of guests) can lead to a substantial jump in costs due to the step nature of the variable costs. Understanding these cost behaviors is crucial for the catering business owner when pricing their services, negotiating with clients, or determining profitability for different event sizes.