How to Reduce Variable Costs In Favor of Fixed Costs
Unpredictable expenses can put unnecessary strain on your budget and slow growth — how can you add more certainty to your costs?
Every business, big or small, has expenses that are predictable and recurring (like payroll), and expenses that are unpredictable and rare (emergencies). A competent finance department can manage both of these kinds of expenses through careful budgeting and saving.
However, there’s a third type of expense that can throw even the most experienced CFO for a loop: one that is both recurring and unpredictable. Unpredictable, recurring expenses are often disguised as good deals. While the phrase, “you only pay for what you use,” sounds fair and appealing at first, you quickly learn that use- or metric-based expenses weren’t designed with your company’s best interests in mind.
As your company grows, its use of software or hourly contractors will increase, and so will the expenses they incur. Why should your business be punished for adding more team members, growing web traffic, or increasing sales?
I’m sharing what I’ve learned about the value of fixed costs in my 15-year career working in and running finance departments at tech companies. Read on to learn about the problem with unpredictable costs, why you should strive for fixed costs whenever possible, and tips for making the switch from unpredictable expenses to fixed costs.
The problem with unpredictable, recurring variable costs
Unpredictable, recurring expenses – like software that charges you for use volume, or hourly freelancers instead of salaried staff – put a strain on your company's budget and slow down the business’ growth.
Cost structure that varies based on metrics, such as web traffic or storage costs, can’t be accurately predicted. For this reason, it’s nearly impossible to budget for these kinds of expenses.
Your finance team can’t be sure how much the company actually spent on software or wages until weeks after the books have been closed. How can you control the company’s finances when you don’t know how much is being spent until it’s too late? The lack of visibility and control of unpredictable, recurring expenses, makes them a CFO’s worst nightmare.
The real value of fixed costs
The best way to combat unpredictable expenses, and establish consistency in recurring expenses, is to create stability and predictability in your company’s spending. How can you achieve this ambitious goal? By choosing fixed costs over metric-based expenses whenever possible.
SaaS companies that charge a flat monthly fee, instead of a fee based on number of users, is an example of a fixed cost.
The value of fixed costs is the predictability and spending visibility they create. There are no surprises when the invoice arrives or the subscription fee is debited at the end of the month. You’ll know exactly how much you’re paying for the service.
Tips for switching from unpredictable variable costs to fixed costs
Avoid the pitfalls of variable expenses by following these guidelines for a successful transition to fixed costs.
Choose project fees instead of hourly contracts
Have you ever hired a freelancer for a project, agreed to their reasonable hourly rate, and then received an exorbitant invoice? Avoid this nightmarish scenario by negotiating project fees or recurring retainers instead of an hourly rate that gives you no control of your spend.
If the contractors you hire only work on an hourly basis, set limits on their hours. It is in your best interest to pay for results and deliverables, and not for how long it takes contractors to do the work.
Avoid transaction fees
Be wary of tools that include transaction-based costs, such as corporate travel management tools that charge booking fees. Instead, look for tools that have a yearly license cost, or fixed monthly subscription. You shouldn’t be punished for maximizing your use of a tool!
Steer clear of unpredictable software licenses
Avoid software that charges by the seat or by usage. If your scaling company is doing a crazy amount of hiring, you’ll be spending a lot more than predicted to get everyone set up with a business email or a CMS login if you have to pay per head. Look for software licenses that encourage growth instead of de-incentivizing it.
Look for flexible commitments
Multi-year software contracts can seem like a great deal (they usually come at a discounted rate), but it’s impossible to know if the tool will be able to keep up with your business needs as the company grows, or if it will be the right tool for your company next year. Avoid long term contracts to give yourself the flexibility to choose the right tech solutions for your company at the right time.
The exercise of creating a budget is only helpful when the budget can be stuck to. Unpredictable, recurring expenditure caused by variable costs determined by metrics, use, or time, can force you to dig into your company’s reserves and jeopardize big picture business goals.
Take control of your company’s spending by choosing fixed costs whenever possible. Prioritize project fees instead of hourly rates for contractors, software licenses with flat fees instead of pricing per transaction, and contracts that give you flexibility.