In the dynamic, liberated economies in which organisations now operate it must be accepted that nothing is fixed anymore, at least, nothing that is long term. But even in this day and age we still teach and use the term fixed cost.
We know that costs vary differently; some are linked to volume and others less so. All accountants will be familiar with the ‘step effect' that characterises some costs but even these will have different timings from cost to cost. Then there are costs that are not linked to volume or turnover at all. EG the cost of the office party held almost at the manager's whim, redecorating the premises or the unexpected plant failure
When all is said and done all costs are variable, in one way or another, so why do we persist in misleading managers (and ourselves) by persisting to refer to them as 'fixed'. We need another way of categorising and managing costs that better suits today's dynamic environment. More on this in my next Blog.
This accounting misnomer of 'fixed cost' seems to have been adopted back in the days when 'contribution accounting' was in vogue. This was often used for pricing those larger orders on the basis that it is better to take an order and keep busy, even if it didn't cover all its overheads; the theory was that we would have to bear these overheads anyway so why not get some 'contribution' towards them. Misused, it was a dangerous practice.
Treating 'fixed costs' as variables doesn’t mean regular redundancies, lay offs, short term hiring, or buying and selling property when we need more or less capacity: it does mean that management has to open its mind to the way the ‘fixed’ resources are managed and utilised. It may mean 6 month contracts for certain services rather long term contracts. It may mean short term leases rather than extended ones and it may mean different contracts for some staff.
This move away from the mind set of ‘fixed cost’ will allow greater manoeuvrability when changes occur in the chaotic and opportunistic markets and rapid economic developments we find ourselves experiencing these days. It is the change in mindset that is the important factor. If managers believe that a cost is 'fixed' they will resist attempts to reduce it. The fact is that the time to review and reduce our costs is today and every day. Its an ongoing process and needs constant reviewing.
This change in attitude in management will often need a culture change across the whole organisation – all managers must embrace this approach, they have to accept that no cost is sacrosanct. The concept of 'fixed cost' needs to be buried, they mean fixed resources and there aren’t many of these anymore.