What Are Step Costs?

Definition and Examples of Step Costs

Step costs are expenses that remain constant for a range of workload. The costs will not fluctuate for a certain range of output, but will abruptly rise or fall after crossing a threshold level.  When you map out step costs on a graph, they reveal a stair-step pattern.

• Alternate names: Step-fixed cost, stair-step cost, stepped cost, step-variable cost

With pricing for accounting software Quickbooks, for example, your costs can increase or decrease based on the number of user accounts needed. For the Essentials Plan of $30 per month, you can create up to three user accounts. The $30 cost remains constant whether you create just one user account or three. The moment you need a fourth account, your costs jump to $40 per month with the next level plan. 

Other examples of step costs for companies include salaries and benefits, which remain a constant cost until a single sharp increase.

How Step Costs Work

For a step cost to occur, the workload must either increase or fall below a certain threshold level. 

When the activity rises above a certain level, the step cost will increase. Consider an example where a production company typically produces 1,000 units in one shift. If demand rises to 1,050 units, the company might create an additional production shift to manufacture more units. The step cost incurred would be the salaries as the company would pay additional salaries for shift supervisors to oversee the additional shift.

The same pattern applies when activity falls below a certain level. For example, if a company's sales were not doing well, management may sell off an entire production line. The step cost for several expenses would abruptly decrease since all expenses related to that production line would be cut.

The threshold for incurring a step cost does not always have a hard number. A customer service manager, for instance, may not hire a new representative in response to a small (but greater than usual) increase in emails and phone calls. The manager may wait until there is enough additional work to support a full-time representative before hiring.

When a company is growing, the higher output can introduce sudden rises in step costs. In some cases, this growth can be a boon to the company’s revenue. There are times, however, when crossing that threshold line for step costs can result in a loss. 

Here’s a simplified example. John is thinking about buying a machine that produces 1,000 units and costs $5,000. Each unit can sell for $20. The revenue generated would be $20,000 (1,000*$20). After subtracting $5,000 for the cost of the machine, the net profit would total $15,000.

After doing market research, John is certain that he’d have demand for at least 1,050 units. This would require buying a second machine, incurring a step cost of $5,000. The revenue generated from only 50 additional units from that machine, however, is only $1,000. Exceeding the threshold (1,000 units) in this case, the step cost ($5,000) would be higher than the revenue generated ($1,000), causing the company to lose profits.

Types of Step Costs

If you look at your business finances, you’ll discover that many of your expenses are examples of step costs.

When opening a new production facility, business owners will need to consider the additional step costs in employee salaries and equipment. Health care and pension contributions can also fluctuate when staffing levels rise or fall below a certain threshold.

Many prisons and jails analyze step costs based on annual prisoner cohort numbers. If cohorts are fewer, step costs fall because there are fewer people to feed, clothe, and monitor. This also leads to decreased demand for staff for those types of labor.

Step Costs vs. Fixed Costs vs. Variable Costs