We often get questions about the concepts taught in CORe and what a sample assignment looks like, so we thought it would be fun to share some of our bloggers' weekly assignment submissions to give additional insight into the program.
These assignments seek to find real-world examples of the concepts taught in the course. This week, we asked students to share an example of an important "fixed cost" incurred by businesses and tell us whether this type of fixed cost would scale well as the business grows. Elizabeth, Conor, Dan, Michael, Sam, and Chelsea share their examples below!
A boat manufacturing business has high fixed costs as it not only needs a large factory in which to produce the boats and to store them until they are shipped out, but it also needs several $1M+ pieces of equipment to make the boats and casings, etc.
Many factories like this will tend to run triple shifts because if the facility has purchased the expensive machinery it can't afford to not have it running. Due to these high fixed costs, the barrier to entry is higher and so there are fewer competitors in the space.
As a result, if a company can get to a point where they are manufacturing above the costs of operating and owning/renting their plants the boat manufacturing business can prove to be a very lucrative one.
The company that I work for is a private English language school in Vilnius, Lithuania. While the main building containing classrooms is owned by the company, there are additional classrooms across the street which are rented. This is a local fixed cost, incurred regardless of whether or not they are currently being used.
In the summer months when people are usually on vacation or taking a break, rent is still paid even though they remain empty. It is worth it to pay the rent as the company knows there will be plenty of use once the school year resumes in September. Were the business to expand, this would be an important fixed cost to consider.
That is, the question of renting or buying classroom space would have large implications.
Novartis is a Swiss multinational pharmaceutical company with approximately $60 billion in sales annually. In the 2014 Annual Report, the Swiss company indicated $9.94 billion dedicated to research and development (R&D). Moreover, the pharmaceutical company spent $14.19 billion in marketing and sales in 2014.
R&D and marketing expenses represent a large portion of their total fixed costs with more than $24 billion! With this amount injected, Novartis creates a barrier to entry for other firms that are considering whether to enter the pharmaceutical market or not.
It is only by going global through a large distribution network will Novartis be able to benefit from economies of scale. By going global, Novartis will target more customers and spread theirs fixed costs better. This also explains why the multinational company has such high marketing costs.
Pfizer, a pharmaceutical company that applies science and resources to discover, develops and manufactures healthcare products like Advil and Centrum. Pfizer is a giant in the pharmaceutical industry and one important fixed cost incurred by their business is research and development.
When producing a drug, the investment in research and development is incurred upfront. The cost remains the same whether Pfizer sells the drug to 1 person or 1 million people.
This fixed cost resides on a global scale, and it scales very well as a pharmaceutical company expands: as a pharmaceutical continues to grow, it doesn't incur more research and development costs on the original drug, and thus it can easily spread these fixed costs across a global scale.
Zipcar maintains a fleet of over 10,000 vehicles in 27 different metropolitan areas worldwide. Car sharing has become an increasingly popular way for urbanites to access a car when they need one without having to deal with the headaches of parking, maintenance, and insurance/ registration fees.
Each individual Zipcar has a "home" parking spot that it must be returned to after every use, and these parking stations are broadly distributed so that no Zipcar member is ever too far from a car. Zipcar's fixed costs reside at the local level: for every new parking station they open, they need to pay the up front fixed cost to buy a car and rent a parking spot in that neighborhood.
Zipcar members benefit from network effects, because as Zipcar expands there are more and more cities and campuses where Zipcar members can access vehicles.
However, Zipcar's fixed costs will expand proportionally to the number of rental locations that they offer. Zipcar can expand effectively, but their fixed costs are not easy to scale.
For bars, pubs, and restaurants wishing to sell alcohol, a liquor license would be really important fixed cost. If the establishment failed to get a liquor license, then it would go out of business pretty quickly! Liquor licenses have to be purchased for each location, so if someone owns a small chain of bars or pubs, then each one will have to have a license in order to legally sell alcohol. Therefore, this would not scale as the business expands.