As a small business, it can be tempting to focus on maintaining low fixed costs and “variablizing” as much of your cost structure as you can. In fact – it’s the prevailing wisdom of most consulting firms! And in most cases, it’s really sound advice.
With capital-light models, however, it’s more difficult to take advantage of economies of scale. While outsourced costs usually incorporate volume discounts, they rarely fall on a per-unit basis as fast as they would if you controlled them fully.
Taking on fixed costs has obvious downsides. Capital intensity, the danger of demand declines, and a lack of operational flexibility are key downsides.
Arrow Electronics is one company that passionately embraced high fixed costs and growing through acquisitions to build scale. With an innovative inventory management system, Arrow competed fiercely on in-stock levels (achieving a 98-99% level, significantly higher than industry standards). With a fixed SG&A base of $1.1B in the early 2000s, the company fought back against macro-demand declines in the post-tech bubble and 9/11 fallout by being massively acquisitive. Where others might have cut costs, Arrow saw the opportunity to dominate an industry and secure a durable, sustainable competitive advantage.
If you’re in a fragmented space where high fixed costs may tempt you to cut down as demand suffers, consider going big and trying to build massive scale. Not right for all industries and times, but the value (Arrow trades well above where it did before consecutive mid 20% demand declines) creation can be massive.
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