Thursday, August 23, 2012
Fixed Costs the Giant Killer
A while back in San Marcos, California, we had a drought and our public water utility requested that everyone reduce water consumption. The plan worked great, with an unexpected consequence. We got a notice from the water utility that rates had to go up because we were consuming less. The water company had fixed costs that weren’t being met because of the drop in consumption.
These fixed costs could lead to cash flow problems in a business that expands too much during good times. They might not be able to meet their fixed costs when times get tough. For example, General Motors doesn’t make a profit on every vehicle. Everything they make up to September or October covers fixed costs. The rest of the year is their profit. Have a bad sales year or pay too much in retirement benefits, you don’t meet fixed costs.
Stores that may be in a trouble are chains like Staples, Home Depot, Lowe's and Wal-Mart. Fixed costs for each store are real, and when times were good, the money rolled in. A drop in consumption of about 15% really hits the bottom line hard. The real pain is felt one tier up in the organization, upper management, the bigger the organization, the more corporate infrastructure that demands fiscal support (i.e. fixed costs).
Internet competition is exacerbating the chain store problem. A brick and mortar store has obvious fixed costs in inventory, that a web based store doesn’t have to contend with. Display a photo and sell. Do it right and you bypass the sales tax.
Chains are starting to downsize. They are closing marginal stores and laying off personnel. The competition in our area is intense. We have 4 Home Depots, 2 Lowe's, 2 Staples and 3 Office Depots within 12 miles of each other. The Office Depot by our place is now closed and I had no idea when I drove over the other day. The Ace hardware I use to go to every Saturday for free popcorn with my son is gone.
We need to step back and realize that things are getting progressively worse only because people are not consuming as they were before. Once we realize that, we can understand why this mess is not going away any time soon. Consumption is what drives our economy. The super stores that displaced all of the mom and pop stores 20 years back now have a problem of being too big. Size does matter in a declining economy. These businesses are asking the question “Do we have the funds to continue operating?”
If we examine government, there is a different view to downsizing. Why bother. And the aggravating thing, any money left over at the end of the year has to be spent or turned back into someone higher up who will figure out how to spend it. So if there was a couple of million left that wasn’t spent, you kind of see how every department got the wide screen TV and the exotic exercise machine. What would happen, I wonder, if the department head got a 10% commission added to his paycheck, for funds not spent and returned to the General Fund? Of course, the taxpayers would never tolerate a State employee receiving a 10 million dollar bonus for cutting welfare by 100 million, or would they? (Can't happen but it sounded funny)
What we can deduce, is that private enterprises that expand, increase their fixed costs. And as these fixed costs increase, they tend to become unmanageable in a recession/depression when they try to downsize. Government on the other hand, has budgets that have been preapproved for spending. Government doesn’t have to make a profit in order to survive.
Both Private and Government entities can file for bankruptcy. This only happens after they have tried everything else. Private businesses fail for lack of consumption on the part of the consumer. Whereas, the problem for most of the city government failures to date, is too much consumption, sandwiched with declining tax revenues.
I was just listening to the nightly news and someone stated that Medicare had until 2023 until it went broke. That put my mind at ease, it’s kind of like the Captain of the Titanic advising the passengers that they get to keep the deck chairs when they leave the ship. The bankruptcies now happening, started 3 to 6 years ago. The business model for government and private enterprise has changed somewhat. Private enterprise will pay for failure by going out of business. Not so with government. They are the only abstract body that can perform a sexual act upon all of its constituents that doesn’t result in a single pregnancy. And if they can do it twice, they’ll probably get a pay raise. You can be rewarded for gross incompetence in the government sector, go figure!
Copyright 2012 by Jim Brubaker