As a practical definition of a fixed cost business, it is one where the fixed cost of the business is greater than 50%. So with each sale, the cost of executing the sale and delivery is a minority (less than 50% of the total cost).
The asset is most of the cost of the transaction. Each month starts off with a large ?nut? to pay for. Generating revenue dollars is critical for this type of business model. If a fixed cost business has paid off its liabilities (which fund the acquisition of the assets), then it can approach 100% gross margin of its sales.
Construction is different, since 80 to 90% of the costs of a firm are the direct costs of projects. All profit is generated by a single purpose: completing projects on time, within budget, safely and with adherence to plans and specifications. There are no other options to generating a profit. The projects are the ?main thing.?
In a fixed cost business, gross margins can be large on each sale, so there is a great incentive to come up with an innovation that increases sales. One innovation or new product can be a ?windfall.? Also, a company can bury mistakes under a pile of profit with a few breakthroughs. Peters?s tremendously in-depth analysis serves a fixed cost business well. Sometimes gross margins on sales can reach over 90%, so an innovation can reap great rewards. The energy spent on finding a better way or product is justified.
Take the example for a new use of an asset such as an airplane. One use is for passengers, but another may be for, 2) package shipments, or 3) use as a charter for private corporations. An innovative idea is to adopt number 2 or 3. The cost of the asset stays the same, but the revenue steam can be increased.
As a simple example, if passengers and package shipments are sent at the same time, revenue dollars are increased and extra operating cost rises minimally. More profit is a result.
Uncovering a way to make an asset more productive especially a machine, intellectual property or even a person can be a boon to a fixed cost business.
In another way, the fixed assets are visible to competitors and others. This makes these kinds of companies a sitting duck. Where private or public, a steel plant or a retail store is a stationary thing viewable upon a public visit. It is hard to be invisible and discrete. So innovating and becoming a moving target is a necessary strategy. That is, if a firm is to beat the competition and thus improve profits quarter to quarter.
Take the firms and leaders who have appeared on the cover of Business Week, Forbes, Fortune, and other leading periodicals or that have been featured in ?In Search of Excellence,? ?From Good to Great,? etc. Many are bankrupt or have a diminished presence in their markets. This is not a reflection on books or their authors, it is a reflection on the nature of U.S. capitalism. Legendary leaders live and die. Many times their company has no equal replacement to them. Also, business conditions change, so the company?s fortunes flag. ?Creative destruction? is a real phenomenon.
This is an excerpt from our recent book, The Practical Construction MBA (2011, 458 pages) for more information ? go to : http://stevensci.com/Merchant2/merchant.mvc?Screen=CTGY&Store_Code=SCII&Category_Code=PCMBABook
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