When should I break down costs as Fixed and Variable as opposed to over the value chain?

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New answer on Feb 29, 2020
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Anonymous A asked on Feb 10, 2020

I want to understand in which situations I should break down costs into fixed and variable and when to use the value chain breakdown.

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Ian
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replied on Feb 11, 2020
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It's not necessarily an and/or. When thinking about FC and VC you should also be thinking about the value chain.

For example:Raw Mats (VC) and R&D (FC) are at the beginning of the chain. Labour (FC or VC), electricity (VC), and rent (Generally FC) are in the middle (production/manufacturing). Transport/shipping/delivery (can be FC or VC) is at the end.

That being said, if you clearly have an operational prompt (i.e. we're seeing bottlenecks that have cause an increae in our costs), then go value-chain. Likewise, if you hear "We've seen costs rising over the past 3 years", and you can generally go FC/VC. However, if you get the same question and you're a vertically integrated company (perhaps Oil&Gas), you may want to talk about both simultaneously (keep it structured though).

Make sense?

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Luca
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replied on Feb 29, 2020
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Hello,

You can use both. In my opinion it's better to use the split Fixed/variable because it helps you to identify what varies with volume and what is an invariant. More over, there are some similarities in the ways to decrease variable costs, that are completely different from the methods to reduce incidence of fixed costs.

Best,
Luca

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Udayan
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replied on Feb 13, 2020
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It might be helpful to do both. Start with FC/VC and then go down deeper into the value chain breakdown

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Clara
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replied on Feb 11, 2020
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Hello!

This is one of the questions for which there is not a "categoric" question, because both breakdowns can be perfectly fine if they are well argumented.

I would say that in most cases, Fixed vs. Variable is an easier way to tackle down these kind of problems. However, keep your eyes open for hints that point you towards a value-chain approach (e.g., issues in the process, total costs of revenues going down in time, etc.)

Hope it helps.

Cheers,

Clara

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Francesco
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replied on Feb 11, 2020
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Hi Anonymous,

they are both fine as a division. Personally I recommend to divide in fix and variable as a first level of your analysis, and use the value chain to then brainstorm costs in each of the two components.

Best,

Francesco

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Vlad
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replied on Feb 11, 2020
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Hi,

It depends on the objective. If you are trying to calculate the synergies between the two companies - it's more clear when you go through the value chain rather than FC / VC split. Also In some complex business, it's easier to draw the value chain and then define the costs in each part (e.g. if the business has mining, production, distribution)

Best

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Antonello
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replied on Feb 11, 2020
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I confirm it depends on the specific case. Generally speaking, FC/VC is always good, and then you can deep dive - depending on the case - with a value chain breakdown

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Anonymous replied on Feb 11, 2020

Hey A,

it is alwoys a case-by-case decision.

Your business judgement and intuitition develops with the amount of cases you have sold.

So more cases your practice the better feeleing you get, when you should apply any specific case structuring.

Hope it helps.

Best,

André

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Ian gave the best answer

Ian

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