Managing high fixed costs
Knowing your fixed costs can help manage your business more effectively. Businesses with high fixed costs will have different strategies for managing their business than those with high variable costs.
Expenses are generally categorized as either fixed or variable. Fixed costs are the expenses that are incurred regardless of how much is sold or how much is produced. Some typical examples of fixed costs are lease payments, insurances and mobile phone cap. Variable costs are the expenses that vary depending on your sales or activity level. Variable costs include expenses such as electricity, phone call charges and subcontractors.
Businesses with high fixed costs need to consider some of the following points when managing their business:
Their breakeven point will start higher than a business with high variable costs. Therefore, pricing strategies may need to focus on volumes and not margins. A webinar, e-book or hosting a seminar are examples where this may apply.
Similarly, the business will need to make sure they sell enough to cover at least their fixed expenses. A business can achieve this by fixing its revenue stream. For example, the mobile phone industry signs customers to a 24 month plan or a consultant seeking a retainer.
Higher fixed costs may lead the business to be less flexible to changing conditions. In an economic downturn, the business may have increased risk or financial pressures if the business cannot reduce the fixed costs as quickly as the drop in revenue.
Conversely, in a growing market there is the opportunity to make higher profits. Once sales have exceeded the fixed costs then further sales will go straight to the bottom line. The business may seek a different market or pricing strategy to increase sales.
Entry barriers are usually higher for high fixed costs businesses. This may lead to higher profits due to less competition.