Question

Describe two real life companies that you believe has a "High Fixed Cost Structure" and one that you believe has a "Low Fixed Cost Structure". Explain why you came to this conclusion. Then describe what would happen to your companies' net income if

a) in one year they were able to double their sales

b) in one year their sales would drop by 50%.

Answer 1

Two real life companies that I believe has a “high fixed cost structure” are Microsoft and IPG Photonics. Microsoft is a software maker and makes the famous software like MS Office, Windows etc. IPG Photonics is a manufacturer of fiber lasers. For both these companies they have a high fixed cost structure that stays more or less at a constant level irrespective of the sales volume of the company.

One company that I believe has a ‘low fixed cost structure’ is Walmart. This company’s level of fixed cost is low and variable cost is higher.

(a): When sales double then net income of Microsoft and IPG Photonics will increase at a higher rate than when compared to Walmart. This is because in case of both Microsoft and IPG Photonics their operating leverage is higher than Walmart. In case of Microsoft and IPG Photonics their fixed costs will remain constant and hence the overall impact on costs will not be much high and in case of Walmart its variable costs will increase and so overall impact on costs will be high. Thus when sales are doubled then net income of Microsoft and IPG Photonics will rise faster than net income of Walmart.

(b): Here again operating leverage will come into picture and when sales drop by 50% then for Microsoft and IPG Photonics its costs will not drop and so its net income will deteriorate or fall faster than Walmart. In case of Walmart sales drop of 50% will be accompanied by almost 50% drop in variable costs and hence its net income will not fall, rather it may progress in the opposite direction.