To understand flexibility within a budget, one must understand the two components of cost: fixed cost and variable cost
In a manufacturing firm such as Bob's Bicycles, variable costs
include direct materials, direct labor, variable manufacturing overhead, and the variable portion of selling and administrative expenses.
In contrast, variable costs
rise or fall in direct relationship with sales.
Company B has a high level of variable costs
, since it purchases its products from another manufacturer.
Depending on the prior output level, even a small increase in FC, depending on the slope of the TR function, with no change in unit variable costs
for simplicity, would require a management decision to increase output, demand permitting, to avoid losses or to maintain desired profits.
The front end of the origination business is also a good place to have a variable cost
structure in place.
You will also find that variable costs
change as volume increases.
As well as averaging less than a third of the fixed cost bill in both cases, variable costs
varied far less between the best and worst performing businesses, suggesting markedly less potential for improvement
Develop process flexibility with variable cost
Under a PAVC standard for competitive pricing, no generator would be built; in any market, competitive or not, even the most expensive "marginal" generator has to expect that prices will, on average, cover not just its variable costs
but also its fixed capital costs.
Transfer Price = Variable costs
per unit + Lost contribution margin per unit
A substantial portion of risk borne by any manufacturer derives from operating leverage: that is, the use of fixed cost investment to lower variable costs