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


dearieme said...

Don't fret. After the collapse of Rome it only took about 1300 years for Britain to get back to the same levels of civilisation.

In the Dark Ages, the wild Welsh tribesmen still referred to themselves as "citizens" so there's a fair chance you'll still be calling yourselves "Americans".

Rob in Nova Scotia said...

Jim just got back from grocery store. I noticed a pound of bacon was on sale for low price of 5 bucks versus the old price of 7. It wasn't that long ago that I could buy it for 4 dollars or less regular price. Anyway I figure the new price is only going to reduce the number of people buying. Less customers means price will rise even more. I suppose the pork producers fixed costs might in the end improve my health. Problem is the food that is good for you is going up in price too.

dearieme said...

@Rob: I hope you're not suggesting that Vitamin Bacon is bad for you.

Jim in San Marcos said...

Hi Dearieme

If it's just a monetary collapse, its no big deal. We'll starve for a couple of weeks and then we start over again.

What is Vitamin Bacon?

Jim in San Marcos said...

Hi Rob

I buy the bacon that has lost its vacume seal. They mark it down to a dollar a pound here. Regular price is still $5 to $6. It frys up into nothing, but it sure tastes good, so it must be bad for you.

Meat went out of sight when we started making ethanol with corn. They want $10 for a T-bone steak.

Notice though, as we refuse to spend more and cut back on the items we use to buy, we are lowering our standard of living. It's kind of nice to know that we are following textbook economics to the letter. We're behaving like trained monkeys :>)

dearieme said...

The vitamins are well known to be A, B, C, D, beer and bacon.

Rob in Nova Scotia said...

My wife read a book about use/misuse of corn for fuel and also as feed for our livestock industry. You are right about lowering our standard of living. The drones calculating inflation are counting on me to substitute something of lower price to take the place of bacon. One of the great things about living in Nova Scotia is you can buy lobster for 6 bucks a pound at supermarket and even less at wharf. I also go out on boat and do a little work and get them for nothing. Anyway as it stands right now balogna and bacon are more expensive than those critters. Too good to be true which means the Mayans might be right and world will end on schedule this december.

Jim in San Marcos said...

Hi Rob

I remember 40 years ago in England, the thrill as a kid of pulling up a lobster trap with something good in it.

I'll probably spoil myself this weekend and buy a lobster. Very tasty!

I'm tending to think that the end of the world might be a month earlier, November 4th election day. But there could be enough disconnect that it drags on into December.

Maybe I'll make it a point to eat a lot of lobsters in November. I don't want them to go to waste at the end of the world :>)