What are step variable and step fixed costs?


Step costs are constant within any range of activity but increase by discrete amounts when activity exceeds that range of activity.

Step costs are costs that are fixed over some range of activity and that increase in a step-like fashion when a capacity limit is reached. This behavior arises because resources have to be acquired and consumed in more or less large chunks. For instance, if you rent pieces of equipment which can each produce 1,000 units in a week, you have to pay this rent once if you produce less than 1,000 units a week, twice between 1,001 and 2,000 units a week, three times between 2,001 and 3000, etc. The important point here is that as soon as you have to produce one unit more than capacity, your costs suddenly jump (in theory) and then remain stable for the next 999 units. This leads to the following shape of the relationship between cost driver and cost:

This peculiar shape typically results from either technological constraints (machines have a fixed capacity) or contractual constraints. For instance, a subscription to cloud services cover specific ranges of activity (e.g. storage space), and going beyond that ranges requires a different subscription. It would theoretically be possible to pay for usage, but service providers usually either do not offer that option or make it very expensive because on their side they need to plan the capacity and cannot afford surprises in consumption levels.

As the following diagram illustrates, step costs result in a quite characteristic pattern for the evolution of the unit cost:

The size of the range over which step costs remain constant distinguishes step variable costs from step fixed costs.

Step variable costs are step costs which are fixed over a narrow range of activity.

Step-fixed costs are step costs which are fixed over a wide range of activity

The distinction between step variable costs and step fixed costs matters, as we will see later, for the definition of the relevant range. The former will typically be treated as variable within the relevant range (resulting in systematic errors, but of small magnitude) while the latter will necessitate changes in relevant ranges.


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