Why IT Managers Need To Find A Balance Between Fixed And Variable Costs

by drjim on December 20, 2012

IT managers need to understand how companies balance products

IT managers need to understand how companies balance products
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In order for you to have a happy, successful, and long career as an IT manager, you are going to have to understand how your company makes money. Since your company is in the business of selling some sort of product or service, it sure seems like we should take a look at just exactly how selling that product is going to help your company keep their doors open and you employed…

How Does A Company Really Make Money?

The first thing that any IT manager’s company is going to want to do is to cover what are called their fixed costs of manufacturing a product. This is those big up front investments that have to be made in the tools of production such as buying a printing press, etc.

Once those fixed costs have been covered, all that is left is paying for the costs of the materials (and labor) that went into producing each additional unit. The equation for this looks like this:

Unit Net Revenue – Unit Variable Cost = Unit Contribution To Profits

It doesn’t take a rocket scientist to see that in order for your company to boost their profits, what they need to do is to reduce their variable costs. This is why you’ll see companies using less packaging, making products smaller, or reducing shipping weight in order to shrink their variable costs.

What Is Operating Leverage?

A business term that you’ll hear quite often is “operating leverage”. This term describes the relationship between a company’s fixed costs and its variable costs.

When a company has high fixed costs relative to their variable costs, they are said to have high operating leverage. The software industry would be a good example of this type of business – most of the costs come in the development of the product, not shipping the next unit.

When a company has low fixed costs relative to their variable costs, then they are said to have low operating leverage. A consulting company is a good example of this. They generally don’t own much equipment, but the bulk of their costs comes from the fees that they pay to their consultants.

The key to understanding operating leverage is to realize that it is a great thing once the company is able to pass the breakeven point where it has covered its costs of creating the product and can now start to generate profit. However, operating leverage can cause a company to experience big losses if they are never able to achieve their breakeven point.

What Does All Of This Mean For You?

As much as most IT managers would like to spend all of their time thinking about IT related tasks, it turns out that we can’t. We really need to know how our company goes about making money if we want to remain aware of what the health of our employer is.

Once a company has sold enough of its product to pay for its fixed costs, it start to focus on what it can do to minimize its variable costs in order to boost its profit. The relationship between a company’s fixed and variable costs is called its operating leverage.

Yes, your IT skills are a critical part of the company’s success. However, you also have an obligation to understand how your company makes its money. This means that you are a member of the team that needs to figure out what the right balance between fixed and variable costs are. Good luck!

– Dr. Jim Anderson
Blue Elephant Consulting –
Your Source For Real World IT Management Skills™

Question For You: What role do you think that an IT team has in helping a company to reduce its variable costs?

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What We’ll Be Talking About Next Time

Those pesky job interviews – management always seems to put them on your to-do list just when you have a million other things to do. Yes, they are important, I mean after all who you hire will shape your IT team for years to come. However, when you are pressed for time, what’s the best way for an IT manager to go about preparing for one of these things?

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