Brief Summary of ‘Make A Wish’

‘Make A Wish’ is a travel agency catering to international and domestic travel services starting from
VISA, air ticketing, accommodation, transportation to medical tourism facilities. The following report
tries to illustrate how the costing for a firm as such is categorized. Make A Wish being a service based
firm differs in terms of its expense categories when compared to a conventional production based firm.

It needs to be outlined that tourism intermediaries may consist of quite different structures depending
within which world region they are operating. The travel distribution in Asia is differently organized than
in Europe or America. Major requirements for setting up a travel agency are a suitable office and agency
agreements from tour operators to sell their products/services. For selling air transport services worldwide
it is necessary to hold a license from IATA and a trade license from the government to begin with. If
travel agencies create and market their own tours, they need to pay or give a financial guarantee for ‘own
production’ called Collateral Securities. These collateral securities are obligatory for all tour operators
too.
The largest cost factor apart from the initial licensing costs for travel agencies are payroll expenses.
Another big factor is the accommodation costs and the administration costs which include printing,
insurance, legal and professional fees, bank charges in addition to the marketing expenses (mostly digital)
etc.

Here’s a sample detailed overview about travel agency operating accounts:

Sales Currency Units

Inclusive tours 5,30 000

Air tickets 3,30 000

Other transport tickets 49, 000

Insurance 10, 000

Car hire 3, 000

Miscellaneous 78, 000

Total 1, 000, 000

 Revenue Currency Units

Commission 96, 000

Other income 5, 000

Total 101, 000

Costs Currency Units

Payroll expenses 46, 500
Communications 12, 000
Advertising 3, 000
Utility 1, 500
Administration 6, 500
Repairs and Maintenance 500
Accommodation expenses 12, 500
Depreciation 2, 500
Total 85, 000

Net income 16, 000

Identification & Analysis of Cost Categories for a Service Firm

1. Fixed Costs and Variable Costs

Cost refer to the prices paid to the factors of production. Prices paid to fixed factors, and the prices paid to
the variable factors are termed as the fixed costs and the variable costs respectively. Thus, the cost of
production of a commodity is composed of two types of costs, i.e., Variable Costs and Fixed Costs, also
called Prime and Supplementary Costs respectively.

Hall & Leiberman (2004) describes breaks down the total production costs of a firm as:

a. Total fixed costs

i. Cost of all inputs that are fixed in the short run

b. Total variable costs

i. Cost of all variable inputs used in producing a particular level of output

Therefore:

c. Total cost

i. Cost of all inputs—fixed and variable

ii. TC = TFC + TVC

Graphical illustration:

Fixed Cost Explained: Fixed costs are those costs which remain constant, irrespective of the level of
output. These costs remain unchanged even if the output of the firm is nil. Fixed costs, therefore, are
known as “Supplementary Costs” or “Overhead Costs”. Fixed Costs, in the short-run, remain fixed
because the firm does not change its size and the amount of fixed factors employed.

For Make A Wish, the fixed costs are the initial licensing costs e.g. trade license, IATA, PATA etc. The
down payment of the rented office along with the monthly rent is also categorized under fixed cost for
this firm. This is because none of these will vary with the number of clients served or the amount of
service provided. These are cost that might recur after every couple of years.

As per the reference listed at the end of the module, the salaries of stuffs are also categorized under fixed
costs. Some employees, especially sales representatives, receive commission-based pay. From an
employer's perspective, such pay is a variable expense, as it rises and falls with sales volume. However,
most employees receive at least some level of fixed payment. Even when employees receive hourly
wages, they tend to work the same amount of time every week unless the employer asks them to do
otherwise. In this way, payroll for non-commission-based pay is a fixed expense.
Variable Costs Explained: Variable costs are the costs which depend on the output produced. For
example, if we produce more cars, we have to use more raw materials such as metal. This is a variable
cost. However, this applies for a production based firm. In case of Make A Wish, the items that vary with
varying quantity of client served are mostly administrative costs such as office supplies (printing,
stationary, utilities bills etc), transportation cost for employees (travelling around to-forth embassy,
client’s place etc).

Another major variable cost is the marketing expense of the company. In this case, the expense is mostly
for digital promotion of the services along with a few printing cost of leaflets, flyers etc.

2. Total Costs:

The Total Cost is the actual cost incurred in the production of a given level of output. In other words, the
total expenses (cost) incurred, both explicit and implicit, on the resources to obtain a certain level of
output is called the total cost. The total cost includes both the variable cost (that varies with the change in
the total output) and the fixed cost (that remains fixed irrespective of the change in the total output).
Thus, total cost includes the cost of all the input factors used for producing a certain level of output.

Often, the economists use two-factor inputs in the cost model Viz. Capital (K) and labor (L). The capital
is considered to be a fixed cost, i.e. will remain fixed irrespective of the production level and per unit
rental price is denoted by ‘r’. Thus the total fixed cost is ‘Kr’. While, the labor, denoted ‘L’ is considered
as the variable cost, which changes in the proportion to the level of production. The wage rate is denoted
by ‘w’ and thus, the total variable cost is ‘Lw’. Symbolically,

TC = FC + VC = Kr +Lw

If it is assumed that the unit variable (labor) cost remains constant, then the total cost is linear in volume
and can be calculated as:

TC = Fixed Cost + Unit Variable Cost X Amount

In case of Make A Wish- the service firm, the variable cost will change on the basis of promotional
activities and administrative activities conducted by the firm. This is because, service firm is not based
on level of production rather based on the amount of services they have provided to the customers.

3. Marginal Costs:

The Marginal Cost refers to the change in the total cost as a result of the production of one more unit of
the product. In other words, the marginal cost is the increase or decrease in the total cost due to the
production of one additional unit of the product.
The marginal cost includes any cost incurred in producing the next unit of the product and hence is
expressed as:

MC = ΔTC/ ΔQ where, ΔTC = Change in total cost, ΔQ = change in quantity

The purpose of marginal cost is to determine the point where the firm reaches its economies of scale. This
can be shown in the figure given below:

The marginal cost curve is a U-shaped curve, which shows that cost starts at higher point and declines
with the increase in the production. The cost declines with the increase in the level of output because of
the economies of scale. When the cost is lower, the firm can hire specialized labor, avail discount benefits
on bulk purchase of raw materials, enjoy the full utilization of machines and equipment, etc.

But after some time, the marginal costs starts rising, which shows, the cost increases with the increase in
the level of output. This is because the curve reaches the point where diseconomies of scale persist. The
costs rise because the resources from the current source might have completely exhausted and the firm
purchases raw materials from other sources at a relatively higher price, hire more management, buy more
machines and equipment, etc.

Till the price charged for the product is greater than the marginal cost, the revenue will be greater than the
added cost and the firm will continue its production. But, as soon as the price charged is less than the
marginal cost, the revenue declines, and it is not wise to expand production.
In case of Make A Wish, Marginal Cost have certain uniqueness associated with it. This is because,
service industry is not based on production basis. Hence, it is something difficult to define for a service
firm.

4. Opportunity Cost:

The Opportunity Cost refers to the expected returns from the second best alternative use of resources that
are foregone due to the scarcity of resources such as land, labor, capital, etc. In other words, the
opportunity cost is the opportunity lost due to limited resources.

Every firm or individual has limited resources, having alternative uses with varied returns. Therefore, the
resource owners employ their scarce resources in the most productive use with an objective to maximize
their incomes and thus, the income expected from the second best use of the resources is foregone. The
opportunity cost is also called as the Alternative Cost.

The concept of opportunity cost can be further elucidated by an example given below: If we invest USD 1
million in developing a cure for pancreatic cancer, the opportunity cost is that you can’t use that money to
invest in developing a cure for skin cancer. In this case, the opportunity cost of the firm is the total
investment of the partners which could have been invested somewhere else or event if it was kept at a
bank to yield interest.

5. Economic Cost:

Economic cost includes both the actual direct costs (accounting costs) plus the opportunity cost. For
example, if you take time off work to a training scheme. You may lose a week’s pay of £350, plus also
have to pay the direct cost of £200. Thus the total economic cost = £550.

6. Accounting Costs:

This is the monetary outlay for producing a certain good or providing a service in this case. For Make A
Wish, accounting costs will include the variable and fixed costs we have to pay.

7. Sunk Costs:

These are costs that have been incurred and cannot be recouped. If we leave the industry, we cannot
reclaim sunk costs. For example, if we spend money on advertising to enter an industry, we can never
claim these costs back. If we buy a machine, we might be able to sell if we leave the industry. For Make
A Wish, the sunk costs would be the cost of travelling to different countries for arranging partnership
signing meetings or any other R&D costs incurred before/while starting the company.
 Hence, a sunk Cost is only considered to justify the choices made in the past, i.e. whether the amount
spent in the past fulfilled the purpose and if not, then how much more amount is to be spent or if the
project is to be withdrawn, such decisions are made.

8. Avoidable Costs:

Costs that can be avoided. If you stop producing cars, you don’t have to pay for extra raw materials and
electricity, sometimes known as an escapable cost. In this case, if Make A Wish stops providing services,
it may not need to run the office and may avoid the utility bill, employee transportation cost.

In case of Market Failure:

 Social Costs: This is the total cost to society. It will include the private costs plus also the external cost
(cost incurred by a third party). May also be referred to as ‘True costs’

 External Costs: This is the cost imposed on a third party. For example, if you smoke, some people may
suffer from passive smoking. That is the external cost.

 Private Costs: The costs you pay. e.g. the private cost of a packet of cigarettes is £6.10

 Social Marginal Cost: The total cost to society of producing one extra unit. Social Marginal Cost (SMC)
= Private marginal cost (PMC) + External marginal Cost (XMC)

Reference:

 http://smallbusiness.chron.com/examples-business-fixed-costs-22571.html
 https://www.economicshelp.org/blog/4890/economics/types-of-costs/
 https://layman-blog.blogspot.com/2010/06/different-types-of-costs-with-examples.html
 http://www.economicsdiscussion.net/production/cost-of-production/8-main-types-of-costs-
involved-in-cost-of-production-and-revenue-with-diagram/13829
 https://businessjargons.com/sunk-cost.html