I just can’t wrap my mind around why a Cyclical company tends to have a high proportion of fixed costs relative to variable costs compared to noncyclical companies.
My thought process is that a cyclical business would be very sensitive to fluctuations in demand, and that therefore in order to survive, their cost structure should have low fixed costs relative to variable costs so they can withstand large changes in demand.
I would appreciate if someone could provide the simplest rationale for why Cyclical companies have more fixed costs relative to variable costs relative to Noncyclical companies.
During a slump in demand, the total variable costs will decrease, but the total fixed costs are the millstone around your neck.
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I suspect this is a correlation vs causation issue.
Many cyclical businesses - autos, chrmicals, retail - have structurally high fixed costs.
Like if you can picture some average Dow plant say, it will have complex processes that run at scale 24/7, with large intensive machinery, and significant flows of product. Very significant fixed costs to have all the infrastructure to move all the input / output elements at scale.
So im not sure that cyclicals have high fixed costs because they are cyclicals. Rather, the businesses that tend to be cyclical happen to have high operating leverage.
You’re right btw, you would try to turn your fixed costs into variable, say by outsourcing. Autos do this by pushing greater and greater content to tier 1 and tier 2 parts suppliers.
But then you have all the problems of outsourcing. And you cant always do that, say when large bulk volumes are processed.
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