Every business must contend with a broad range of costs and expenses associated with startup, operations, and growth.
Some of these costs remain relatively constant over time. For instance, unless you’ve moved or signed a new lease, the cost of rent for storage or manufacturing facilities will stay the same. However, other costs can vary significantly as your business grows. These are called variable costs.
Ahead, you’ll learn the definition of variable cost, how variable costs can impact the profitability of your business, and how to find total variable cost and average variable cost.
What is variable cost?
Variable cost is a business expense that rises or falls in direct proportion to production volume. The more goods a company produces, the higher variable costs become and vice versa. While total variable costs change based on production volume, the variable cost per unit produced remains constant.
Imagine a candle company that is busy getting ready for the holiday season (the time of year when it sells the most candles). For each candle made, the company needs to purchase a fixed amount of wax, wick, glass containers, and fragrance oils.
If the company produces 1,000 candles, the company must buy enough materials for 1,000 units. However, if demand surges and the business needs to produce 5,000 candles, material costs will increase fivefold. Similarly, if production slows to 500 candles, the total material cost decreases. This direct relationship between production volume and total cost is what defines a variable expense.
Total variable cost vs. average variable cost
The total variable cost is the overall expense that changes with the level of production, and the average variable cost is the total variable cost divided by the number of units, showing the variable cost per individual product.
To calculate the total variable cost, multiply the variable cost per unit by the number of units produced. While total variable cost rises with production, the average variable cost typically stays constant unless there are efficiencies or bulk savings.
Fixed cost vs. variable cost
Now let’s look at the difference between a fixed versus a variable cost. Variable and fixed costs both represent key expenses of running a business. However, while a company’s variable costs change depending on production, fixed costs remain the same even as production and sales volume changes.
To better understand how the two compare, check out these common examples of monthly fixed costs and variable costs:
| Common fixed costs | Common variable costs |
|---|---|
|
|
Variable and fixed costs are key elements of break-even analysis, which helps businesses determine what they need to do or produce in order to make a profit on their initial investment.
What are semi-variable costs?
Also referred to as mixed costs, semi-variable costs are only partially consistent regardless of production levels. Potentially, semi-variable costs increase as production needs rise.
For example, a company’s electricity bill might have a fixed base charge plus additional costs that rise with machine usage. Or a salesperson’s pay could include a fixed salary plus commissions based on hitting a certain sales volume.
Variable cost vs. marginal cost
Is marginal cost the same as variable cost? While variable cost often measures the cost to produce each unit, marginal cost considers the total cost of production (including both fixed costs and variable costs) to find the cost of producing one additional unit with the goal of maximizing efficiency in the manufacturing process.
How to calculate variable costs
Not sure how to find variable cost per unit? When you’re ready to calculate what your variable costs are, you need to bust out a calculator and the handy variable cost per unit formula:
Variable cost formula
Where fixed costs are simply added together to find a company’s total fixed costs, variable costs must be multiplied. The total variable cost formula is:
Total variable costs = Production output x Variable cost per unit
Average variable cost formula
If you want to calculate the average variable cost, you need to find the total variable costs first. Once you have that number, you’ll use this formula:
Average variable costs = Total variable costs ÷ Production output
How to find variable cost: example
To make it easier to understand what variable costs are, let’s look at an example of variable cost and how to find average variable cost.
Imagine a small company that makes custom water bottles. Their variable costs—including materials, packaging, and direct labor—come out to $2.57 per bottle. If the company produces 10,000 bottles for a large event order, their total variable cost would be:
Total variable cost = 10,000 units × $2.57 per unit = $25,700
Since the cost per unit remains constant, the average variable cost is:
Average variable cost = $25,700 ÷ 10,000 units = $2.57 per unit
This example illustrates how total variable cost rises with production volume, while the average variable cost per unit stays the same.
Common types of variable costs
Variable costs vary from business to business, but here are a few common types:
Raw materials
If you’re manufacturing your own product, these costs are allocated to the materials you purchase in order to produce the goods. This is a variable cost that should remain fairly consistent.
Direct labor
The one variable cost you may have difficulty negotiating is direct labor costs. One strategy for reducing those costs is to switch to a payment-per-piece produced rather than an hourly wage. That way, labor costs are truly tied to production.
Shipping
Shipping expenses vary depending on the shipping method, location, and package size and weight.
💡 Tip: Using Shopify Shipping’s pre-negotiated carrier rates to trim per-package costs and keep this line item predictable.
Commissions
If you operate on a commission structure, either for associates or brand ambassadors, for example, this is another variable cost to consider. It changes depending on the way you have commission structured and number of products sold.
Utilities
Utility needs like gas, electricity, and water can increase as production volume grows. Be ready to budget for increased utility spending if you anticipate greater production needs.
Credit card fees
Credit card fees are a variable cost because they vary depending on sales volume. In some cases, you may pay a flat subscription fee for credit card processing, but these vary for most businesses.
If you enable Shopify Payments, card fees stay flat and transparent, making it easier to model the fee portion of your variable costs. You pay the credit card rate, but you don’t pay a transaction fee for orders processed through Shopify Payments.
Packaging
Product packaging and shipping materials are another necessary cost. These vary depending on the quality, material, and design of packaging as well as the total amount of packages and their sizes.
Example of a variable cost
What is the difference between a fixed cost and a variable cost? Let’s use a bakery as an example to make it easier to visualize how variable costs work.
Every time the bakery makes a loaf of bread, it must purchase ingredients like flour and yeast. These costs rise with each loaf, making them variable costs. On the other hand, expenses like rent for the bakery space and monthly insurance premiums are fixed costs — they stay the same whether the bakery makes 100 loaves or none at all.
Here’s how it might look:
| Type of cost | Example | Cost behavior | Cost per month (assuming 1,000 loaves) |
|---|---|---|---|
| Variable cost | Flour, yeast, butter and packaging | Increases with production | $2 per loaf × 1,000 loaves = $2,000 |
| Fixed cost | Rent, insurance, and equipment lease | Stays the same | Rent = $1,500, Insurance = $200 |
Total Variable Costs = $2 × 1,000 loaves = $2,000
Total Fixed Costs = $1,500 (rent) + $200 (insurance) = $1,700
Even if the bakery makes no bread one month, it would still owe $1,700 in fixed costs. However, the $2,000 in variable costs would disappear if the bakery produces no bread.
Why is understanding variable costs so important?
- Consistent profitability
- Protection during slow sales periods
- Competitive advantage
- Price determination
- Establishes break-even point
- Helps business planning
Variable costs can have a significant impact on your business. Below are some ways variable costs impact your business:
Consistent profitability
A business with higher variable costs relative to fixed costs is likely to have more consistent profitability. That’s because the break-even point is lower, due to lower fixed costs and higher variable costs yields lower profits per unit sold.
Protection during slow sales periods
It’s important to plan for rainy days, not just sunny ones. A company with higher variable costs can bear economic downturns more easily by reducing production.
Competitive advantage
Conversely, a company with a higher proportion of fixed costs to variable costs requires a significant upfront investment, but will likely enjoy lower competition and higher profits once fixed costs are covered.
That’s because once you break even, profits are higher per unit, thanks to lower variable costs.
Price determination
Knowing your variable costs is important to ensure you’re pricing profitably.
If you don’t accurately account for variable expenses when setting prices for your products, you could end up selling products at a loss without realizing it. Understanding variable costs helps you establish a minimum price point that covers both production expenses and contributes to overall profitability.
Establishes break-even point
Understanding your variable costs is key to calculating your break-even point (aka the number of units you must sell to cover all your costs).
By being aware of what both your fixed and variable expenses look like, you can pinpoint when your business will start turning a profit. This helps you set realistic sales goals and monitor progress more effectively.
Helps business planning
Accurately tracking variable costs helps businesses create more precise budgets, forecasts, and growth strategies.
You need to be able to anticipate how expenses will change as production scales up or down, ensuring you allocate resources wisely and make informed decisions about pricing strategy, hiring, production and expansion.
Can variable costs be lowered?
While variable costs generally increase with more production, it’s possible to lower variable costs by achieving economies of scale. For instance, by focusing your manufacturing on fewer products, you can save on costs associated with running multiple product lines, including sourcing materials, maintaining equipment, and managing different business units.
In addition, as your production volume increases, you gain leverage to negotiate more competitive prices for variable costs, like raw materials and shipping, further decreasing your variable cost per unit.
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Variable cost FAQ
What is the difference between fixed and variable costs?
Businesses manage a variety of both variable and fixed costs. Fixed costs are expenses that remain fairly consistent (like rent) and variable costs are ones that ebb and flow in direct proportion to production volume like shipping expenses or the cost of materials.
What are some examples of variable costs?
Examples of variable costs incurred include raw materials, sales commissions, packaging and shipping, manufacturing labor and credit card fees.
Are utilities a fixed or variable cost?
Bills for utilities like electricity may increase when production goes up, so they are a variable cost.
Is advertising a fixed or variable cost?
Unless you have a contract that locks in your advertising spending for an extended period of time, most businesses view advertising as a variable cost. Companies have the option to adjust their advertising spend based on their sales goals and budget, which makes it a variable cost.
