Optimizing Operational Flexibility: Redefining Cost Behavior

Considering the successive changes in the business environment, the rapid growth of technology, and the strong entry of Artificial Intelligence applications into operating and innovation options, it has become necessary for companies wishing to remain competitive and maintain their market shares to work hard to reduce their costs to create sufficient flexibility to deal with these variables.

Rethinking Fixed vs. Variable Cost Dynamics

This is the usual view of many entrepreneurs and executives, and we never doubt its validity. However, there is another view that is very important to be considered alongside that traditional view, which is the necessity of working to restructure operational expenses between the fixed part and the variable one.

Balancing Profitability and Market Flexibility

The ability of organizations to reduce the fixed portion of expenses compared to the variable portion gives them a more flexible ability to deal with the risks of market decline, contraction, and seasonality. For example: If the total operating expenses of company “A” are 100 million dollars, with 60 million dollars in fixed costs and 40 million dollars in variable costs, and the operating expenses structure of competing company “B” is 120 million dollars, with 30 million dollars in fixed costs and 90 million dollars of variable costs, and assuming that the two companies are equal in gross profit margin, Company B’s ability to deal more flexibly with market variables and the seasonality of supply and demand will be higher than Company A, which achieves a higher net profit rate than Company B in normal circumstances.

Prioritizing Flexibility over Margins

Large organizations, particularly those with extensive geographic operations and significant overhead costs, should prioritize mitigating the financial risks associated with market volatility over the pursuit of higher net profit margins than their competitors.

The potential losses incurred from failing to cover their fixed costs could far outweigh any additional profits gained in comparison to their peers. Therefore, if these organizations can successfully transform a substantial portion of their fixed costs into variable costs, they will enhance their flexibility to adjust to market changes and reduce the likelihood of financial losses.

Strategies for Operational Flexibility

To this end, the optimal approach to building a flexible and balanced expenditure structure can be achieved by relying more heavily on the use of short-term lease contracts for the largest possible size of assets rather than acquiring them, relying on outsourcing rather than direct recruitment, and toll manufacturing instead of investment in expensive production lines. Furthermore, the third-party logistics (3PL) contracts could be a better option when it comes to inventory management.