Do We Really Need to Reduce Fixed Costs?

Given the tough economy over the past few years many businesses have experienced declining sales.  To offset the negative impact of  lower sales there are a number of options to help maintain profitability that are typically considered.  For the most part, the options are:

1.   Increase sales through new markets, products, processes, etc.

2.   Decrease variable costs,

3.   Improve mix of sales to higher margin products/services, and

4.   Reduce fixed costs.

In the many discussions I participate in, regarding this subject, the initial reactions seem to be that a return to profitability rests on:

1.   Higher sales, and

2.   Increased sales of higher margin products.

Both of these action may help profitability; however, there is more risk inherent in those paths than in other options.  If your company has had low to negative profits for the last year or two I strongly recommend reviewing your fixed costs.  To determine the right number I would estimate a conservative variable profit and then back into fixed costs.  Choose a fixed cost level that leaves solid, overall profitability for your industry.  A conservative variable profit can be determined based upon historical sales and margins adjusted for known changes.

Reducing fixed costs can be painful. It often impacts the employees and/or the owner directly due to the headcount reductions and decreases in health care and other benefits. However, once the fixed costs are adjusted the owner can focus on finding activities and generating better margins by:

1.   Increasing sales,

2.   Improving product mix, and

3.   Decreasing variable costs.

From my vantage point, the current economic conditions represent an opportunity for business owners.  The survivors will be leaner and stronger.  Survivors  make hard choices and take timely action as necessary.  If you take advantage of this historic time you can propel your company into greater profitability in the future.  If you fail to take swift and decisive action your fixed costs my drive your company to failure.

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