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  • Writer's pictureJoel White

Incremental Cost Modeling

A company pricing for growth needs to assume such growth will change the margin structure of the company as new projects/units/etc. are sold. Yet many companies model their cost rates using an approach that allocates the company’s current costs over its total current year revenue outputs (hours, FTE, users, etc.), which just reinforces the status quo.

If you’re a startup or small and rapidly growing, this becomes even more challenging- especially if you're not yet profitable.

Consider incremental cost rate models instead. The below examples give a picture of what a truly incremental cost rate model would (and would not) include for, in this case, additional billable employees.

Include these types of costs:

  • Salaries

  • Benefits

  • Social taxes

  • Bonus plan applicable to the role

  • Line management- if you hired 20 more people in that role, you would have to hire more Line Managers

  • Training

  • Remote office stipend

Do not include:

  • Sales & Marketing – selling a new project does not require you to spend more on S&M

  • Executives- hiring more Project Managers does not mean you hire a second CEO, CFO, department heads, etc.

  • Recruiting- I often keep these costs out because the recruiting cost of a new hire is usually one-time (sign-on bonus, recruiter fee) and indirect, but there are situations where these could be logically included (e.g., firms that routinely recruit for specific clients or projects)

  • Stock options

Gray areas:

  • Facilities- more office based staff means more office expenses, the trick is knowing whether new hires will be in-office, how much to proportion, etc.

  • Sales commissions- requires its own post to explain

  • Software licenses- unless you can segment which costs relate to each incremental hire (e.g., Microsoft Office, Adobe Photoshop, Salesforce), I often exclude these or use an estimate.

Each company's situation has its own peculiarities, so contact me to discuss yours further.



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