When people/investors first come across the concepts of fixed cost and variable cost of business, they usually think that the meaning is related to whether the value is fixed or variable, but in reality, their relationship is not with their value itself, but the relationship with production. If production increases and the cost follows, increasing along with it, then it is a variable cost, but if production increases and the cost does not follow, that is, it does not increase either, then it is a fixed cost.
Let's understand a little more in depth what fixed costs and variable costs are, citing some examples and at the end we will present the importance of knowing them for a business, citing one of the most well-known companies in the pop world, which is Netflix, which if you know about Streamings, you will certainly know about Netflix's business model. Come find out!
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What is Fixed Cost?
The fixed cost is one that remains unchanged, within a limit, regardless of the company's level of activity and production. Fixed Cost is the part of the costs that will remain unchanged, the value will be the same whether the company produces 1 unit or 100 thousand units of the product. The importance of knowing the fixed costs of companies is to know how many units will need to be produced so that they can pay the fixed costs that the company has and use production to the maximum so that this value is diluted among the products. Increasing production will make this cost better utilized. It is interesting to observe whether the company continues to expand and make use of its current structure to the best possible capacity. To do this, it is interesting to look at the company's assets.
The most common example of a fixed cost is the rent for the company's office, factory or store. No matter how much you sold, at the end of the month, you will need to pay rent. If you managed to sell more that month, this cost will be divided between the units sold. A fixed cost that is not known is the salary of administrative employees, because even if production increases, you will not need to hire more administrative employees, but rather operational ones.
What is Variable Cost?
Variable Cost, in turn, is one that varies in proportion to a company's production volume. This is the most sensitive cost to changes in the company's operations. If it is possible to reduce part of the variable costs, the price of a unit will be cheaper and the product will become more competitive. Among the most common examples of variable costs are raw materials, because if you need to produce more pencils, for example, you will need more wood and more graphite. For a business, it is important to know when the seasonality of the products offered by it has the greatest demand, so that it prepares sufficient stock for these moments, so as not to run the risk of running out of raw materials or even having an increase in price, due to a sudden increase in demand.
Furthermore, another variable cost is direct labor, because as production increases it will be necessary to hire more factory floor employees to handle the greater number of products. It is curious to think about the issue of the variable cost of employees, because recently we have heard a lot about AI and autonomous robots, which are coming to replace the operational level of an industry, but will continue to need more robots when production increases, which shows how the concepts remain relevant, even with technological changes.
The Importance of Costs for a Business!
Understanding the costs of a business is essential to understanding whether the company is spending a lot and whether it spends efficiently. If the company does not understand its costs, it cannot price its products correctly. After all, the bill for a popcorn seller is not simply, I bought the corn, the oil, and the package, I sold everything for X, I take out the material costs and I make a profit. It's not like that, because you have to consider the wear and tear on the popcorn cart, the pan, the time you work, your food, etc. Understanding costs is essential to know how much you need to produce per month, how many products at what price are needed to pay for the operation.
Now let's present a more practical example, citing Netflix and differentiating the company's fixed and variable costs in general. In the case of Netflix, the company's fixed costs are: salaries of the administration team, the corporate structure, marketing, which generally has a standard budget and an amount allocated to the production of original content and development of the platform. These are values that will not vary much with the number of subscribers, it will have administrators, an office, a budget for marketing and another for developing content.
Regarding variable costs, which are those that will increase if the number of users increases, they start with the payment processing fee, in which part of the subscription goes to card services and intermediation software. We also have data infrastructure costs, where more users require greater bandwidth and a greater number of available servers. Finally, the number of employees in customer service, even though the robots are present, there is still an option at the end of the calls to speak to an agent. If the number of users increases, the number of agents needs to increase so that there is no delay in service.
