How to Control Costs as You Grow: Advice From an Economist

This article is an excerpt from the Shortform book guide to "The Voltage Effect" by John A. List. Shortform has the world's best summaries and analyses of books you should be reading.

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What causes runaway costs? How can you keep your costs from spiraling out of control as your business scales?

Managing costs is vital as your organization grows. When scaling up, you can take certain precautions to stay on top of overhead costs and per-unit expenses and keep them at a level that allows for sustained profitability.

Continue reading for tips from economist and professor John A. List on how to control costs over time.

How to Control Costs

Runaway costs occur when per-unit expenses unexpectedly increase as your organization scales. Generally, as you scale up a product, your unit cost should decrease, since you’ll be able to take advantage of increased efficiency and lower component cost, while overhead costs remain the same. However, if your idea’s unit cost increases as you scale up, it may not become profitable, leading your idea to fail at scale. So, it’s important that you learn how to control costs from the start.

(Shortform note: Runaway costs are especially common in organizations that purchase cloud computing services for internal use. While the convenience of cloud computing is attractive to many startups, experts note that the cost of cloud services can skyrocket as your organization scales. This effect occurs because vendors usually charge for each element of their cloud services as a recurring expense, much like a subscription. This means that as your organization scales up, its growing use of storage and other services also becomes a recurring expense. By contrast, when you use traditional, in-house computing infrastructure, upgrading storage or processing power is a relatively simple, one-time fix that comes at a flat fee.)

To avoid being blindsided by runaway costs, when calculating your costs and setting prices before launching a product, overestimate your costs to account for the unexpected. By overestimating your costs, your business can remain profitable even if you end up having to spend more money than you’d like.

For example, suppose you’re a new restaurant owner, and one week, your fridges fail, causing all your ingredients to spoil. If you had overestimated your costs beforehand, and set aside extra funds for unexpected expenses, you’d be able to afford to replace your stock. However, if you haven’t planned for unexpected expenses and have emptied your bank account just getting the restaurant open, you’ll likely have to close up shop at least temporarily, while you figure out your next steps.

(Shortform note: While List recommends leaving room in your budget for unexpected expenses, he doesn’t specify how much money to set aside. According to some experts, for small businesses, you’ll want to reserve an additional 20% of your organization’s total budget to be truly prepared for unexpected costs.)

List also recommends doing whatever you can to lower your overhead cost before your product launches. By lowering your overhead, you’ll be able to introduce your product to the market at the lowest possible price point, which will allow you to target a wide audience. Additionally, the lower your overhead costs, the sooner you can make them up and begin to profit.

(Shortform note: Permanently switching to remote work can be an especially effective tool for reducing overhead costs. While many businesses shifted to remote work by necessity during the Covid-19 pandemic, major companies such as Yelp, Airbnb, Spotify, and Lyft have embraced remote work as a cost-cutting measure. As a growing portion of the workforce seeks remote work, going fully remote may be a win-win in terms of attracting talent and lowering overhead costs.)

How to Control Costs as You Grow: Advice From an Economist