It’s surprisingly inexpensive to start a business today — as little at $5,000, reports Fortunly. However, as encouraging as that is to aspiring business owners, the costs to run that business every day are a bit more complex.
Before research and development, and before you even rent an office space, you might want to know how much money you’ll need to make your product. These are your direct costs.
Direct Costs
Direct costs are what you spend specifically to develop and maintain your product or service. These costs can vary over time as the product is improved upon. Direct costs range from employee salaries to the price of the items needed to build each unit of your product.
Are direct costs different from fixed and variable costs?
Actually, direct costs are a type of fixed or variable cost. These expenses are not mutually exclusive. Whether or not a direct cost is fixed or variable simply depends on how likely (or regularly) the cost is to change as your business grows. Here are two examples:
- Variable direct cost: A SaaS company that sells cloud-based software is responsible for storing the data their customers put on their software. That information is stored on servers. The more clients the company has, the more servers the business will need to buy to store client data so the product can continue to operate. Server costs, in this case, are a variable direct cost to the business.
- Fixed direct cost: Consider the variable cost example, above. This company also employs an IT administrator to manage the storage of its customers’ data. Barring changes to his/her compensation, the salary the company pays this administrator remains unchanged each month. IT salaries are a fixed direct cost to the business.
Direct vs. Indirect Costs
Direct costs are invested “directly” in the development of a product or service. Indirect costs may affect the business’s overhead, but they do not directly contribute to the creation and quality of that service. These costs include office space rent, office security, and staff supplies.
Direct costs get their name because they have a “direct” line to the creation and management of your goods and services. You pay cost A in exchange for item B, you use item B to make product C. Cost A is a direct cost because product C can be traced back to the cost A you paid.
Indirect costs are more complicated and do not have this direct line to your product’s end result. You pay cost A in exchange for facility B, you use facility B to host machine C, machine C is used by team D to make product E. Cost A is an indirect cost because product E cannot be directly traced back to the cost A you paid. There are other direct costs that took place between A and E.
| Direct costs | InDIRECT costs |
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The physical materials needed to make your product. The servers needed to power your ecommerce site. The salaries and commission you pay employees to produce and sell your product. Transportation methods that get your product to the customer. |
The rent prices and fees that come with facilitating an office. Expenses needed to keep your team happy and motivated. (i.e. office perks or team lunches.) Supplies needed to help your office run smoothly. Technology and IT that doesn’t directly help produce products. |
Examples of Direct Costs
- Physical materials
- Employee salaries
- Sales commission
- Servers
- Data center spaces
- Product transportation
It’s easy to attribute your direct costs to the money you spend physically making your goods and services. An automotive company, for example, might pay a steel manufacturer for the material used to create each car body. This is a direct cost to the car company.
However, there are other direct costs that can go into a product even if those costs don’t pay for the material your product is made out of. Here are some common examples of direct costs you can attribute directly to your product:
Physical materials
The raw materials, ingredients, and parts needed to build your product are all direct costs to your business.
For example, if sell computers, you’ll need to factor in the materials needed for the screen, the keyboard, and the hard-drive, as well as any other material needed to build the device when designating a cost for it.
Employee salaries
The individual salaries, particularly the ones you pay to those who make and sell your product, are direct costs.
If you hire any freelancers or contractors, you’ll also want to factor in how much money you will need to spend on their labor.
Sales commission
This is different than salary and is usually specific to salespeople, which often work partially on commission.
Every time a salesperson sells a unit of your product, he/she is paid commission. This is a direct cost to maintaining the value or your product. Compare how many units you’d like to sell with the commissions you’ll pay every time they get sold.
Servers
In 2020, almost every business needs some sort of a website. Meanwhile, every website needs a server. The servers needed to store customer data on your product, particularly if your product is in the form of software, is a direct cost to your business.
While you might be able to trim down costs buy building your website on a CMS that provides server support, you should still factor in the costs you’ll need to protect and store your data.
Data Center Space
Just paying for your servers isn’t the only thing you might have to factor in. You also might need to consider where you’ll place them and how much that could cost. Data center space you rent or own to store those servers is a direct cost.
Product transportation
Once a customer buys a product, how will it get to them? Will it come in the mail, or will a delivery tech from your company bring it? You’ll need to determine which strategy you’ll use and add up the costs associated with that. While mail will result in regular shipping costs, having your own company deliver it will results in costs of labor and costs related to purchasing your own modes of transit, such as trucks.
Click here to learn more about the types of variable costs you’ll encounter when growing your business.
Editor’s Note: This blog post was originally published in March 2019, but has been updated for comprehensiveness.
