Is reducing variable costs the best way for a business to improve profit? Justify your answer.
CAMBRIDGE
O level and GCSE
Year Examined
October/November 2023
Topic
Recruitment
👑Complete Model Essay
Do you think reducing variable costs is the best way for a business to improve profit? Justify your answer.
Businesses are always striving to improve profitability. While reducing variable costs can seem like a straightforward solution, it's crucial to consider if it's the most effective approach. This essay will explore various strategies and argue whether reducing variable costs is the optimal way to enhance profits.
Reducing Variable Costs
Lowering variable costs, like using cheaper materials, directly impacts the cost of goods sold. This can lead to several benefits:
- No need to increase prices: Unlike other methods, reducing variable costs doesn't necessitate raising prices, potentially alienating customers.
- Reduced break-even output: Lower production costs mean fewer units need to be sold to cover expenses, improving profitability sooner.
- Increased gross profit margin: A larger gap between selling price and cost of goods sold translates to higher profit per unit.
However, this approach has potential downsides:
- Compromised quality: Cheaper materials can result in lower-quality products, potentially harming brand reputation and customer loyalty.
Alternative Strategies
Several other strategies can be employed to improve profitability:
Increasing Prices
- Increased revenue: Higher prices directly translate to higher revenue per unit sold.
- Improved brand image: Premium pricing can be associated with higher quality, potentially enhancing brand perception.
Nevertheless, this strategy carries risks:
- Lower customer base: Higher prices can deter price-sensitive customers, potentially reducing sales volume.
- Reduced competitiveness: Increased prices might make the business less competitive compared to rivals.
Increasing Sales Volume
- Higher revenue: Selling more units, even at the same price, leads to increased overall revenue.
However, this can lead to:
- Increased marketing costs:Attracting new customers often requires investment in advertising and promotion.
- Competitive response: Competitors might respond with their own promotions, potentially negating the intended impact.
Lowering Fixed Costs
- Reduced break-even output: Similar to reducing variable costs, lower fixed costs mean reaching profitability sooner.
However, this approach has limitations:
- Limited flexibility: Fixed costs like rent are often contractual and difficult to change in the short term.
Justification
While reducing variable costs can be tempting, focusing solely on cheaper materials risks sacrificing quality and ultimately harming the brand. A more balanced approach might involve increasing sales volume through strategic marketing and promotions. While this might increase marketing costs, the potential for attracting new customers and generating higher revenue could outweigh the additional expense. This strategy allows a business to maintain product quality, protecting its reputation and ensuring customer loyalty, while simultaneously driving revenue growth.
Is reducing variable costs the best way for a business to improve profit? Justify your answer.
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Do you think reducing variable costs is the best way for a business to improve profit? Justify your answer.
Businesses are always striving to improve profitability. While reducing variable costs can seem like a straightforward solution, it's crucial to consider if it's the most effective approach. This essay will explore various strategies and argue whether reducing variable costs is the optimal way to enhance profits.
Reducing Variable Costs
Lowering variable costs, like using cheaper materials, directly impacts the cost of goods sold. This can lead to several benefits:
- No need to increase prices: Unlike other methods, reducing variable costs doesn't necessitate raising prices, potentially alienating customers.
- Reduced break-even output: Lower production costs mean fewer units need to be sold to cover expenses, improving profitability sooner.
- Increased gross profit margin: A larger gap between selling price and cost of goods sold translates to higher profit per unit.
However, this approach has potential downsides:
- Compromised quality: Cheaper materials can result in lower-quality products, potentially harming brand reputation and customer loyalty.
Alternative Strategies
Several other strategies can be employed to improve profitability:
Increasing Prices
- Increased revenue: Higher prices directly translate to higher revenue per unit sold.
- Improved brand image: Premium pricing can be associated with higher quality, potentially enhancing brand perception.
Nevertheless, this strategy carries risks:
- Lower customer base: Higher prices can deter price-sensitive customers, potentially reducing sales volume.
- Reduced competitiveness: Increased prices might make the business less competitive compared to rivals.
Increasing Sales Volume
- Higher revenue: Selling more units, even at the same price, leads to increased overall revenue.
However, this can lead to:
- Increased marketing costs:Attracting new customers often requires investment in advertising and promotion.
- Competitive response: Competitors might respond with their own promotions, potentially negating the intended impact.
Lowering Fixed Costs
- Reduced break-even output: Similar to reducing variable costs, lower fixed costs mean reaching profitability sooner.
However, this approach has limitations:
- Limited flexibility: Fixed costs like rent are often contractual and difficult to change in the short term.
Justification
While reducing variable costs can be tempting, focusing solely on cheaper materials risks sacrificing quality and ultimately harming the brand. A more balanced approach might involve increasing sales volume through strategic marketing and promotions. While this might increase marketing costs, the potential for attracting new customers and generating higher revenue could outweigh the additional expense. This strategy allows a business to maintain product quality, protecting its reputation and ensuring customer loyalty, while simultaneously driving revenue growth.
Extracts from Mark Schemes
Do you think reducing variable costs is the best way for a business to improve profit? Justify your answer.
Award up to 2 marks for identification of relevant issues. Award up to 2 marks for relevant development of points. Award 2 marks for justified decision as to whether reducing variable costs is the best way for a business to improve profit.
Points might include:
- No need to increase prices [k] as this could result in fewer sales [an]
- Would reduce break-even output [k]
- Increase (gross) profit margin [k]
- Cheaper materials may lower quality [k] damaging reputation [an]
Other ways might include:
- Increasing prices [k]
- May increase revenue [an]
- May improve brand image [an]
- Lead to lower customers / could make them less competitive [an]
- Increase number of sales / quantities sold [k]
- May increase costs of advertising [an]
- Competitors may respond with own promotion [an]
- Lowering fixed costs (or examples such as lower rent) [k]
- Reduces break-even output [an]
- Unlikely to be able to change fixed costs quickly [an]
Justification might include:
It could buy cheaper materials to lower variable costs [k] but this could mean poorer quality goods [an]. It could increase the quantity sold [k] but this might increase its promotion costs [an]. Increasing the quantity sold is a better method because the reputation of the business is protected so existing customers should remain loyal [eval] and the additional revenue should hopefully cover the extra cost [eval].
This is a general question so there are no marks for application. For evaluation to be awarded justification will usually follow on from relevant analysis of points. Some points could be awarded for different options, but do not award the same point twice.