One of the keys concepts in managing a business is the understanding of fixed and variable costs and how they can be used in practical applications. This article will define the terms using specific examples from the hotel industry.
The basis for each example is a hotel with 100 rooms.
Variable Cost
Variable costs are the total expense changes as volume changes. Room supplies are a common variable cost. The supplies are directly related to the number of rooms that are filled.
If there are 50 guests, they will use 50 soaps (one would hope). If there are 60, then 60 soaps would be used.
Fixed Cost
Costs are identified as fixed if they do not change as volume changes. For instance, a late night registration desk would be attended by one person, whether there was one guest or one hundred.
Often buildings and their associated costs are considered fixed, since they are not affected by small changes in volume. Interest and depreciation are other examples of fixed cost.
Step-Variable Cost
An additional category, referred to as step-variable, is for costs that change with volume, but in increments. If housekeeping staff can clean no more than 10 rooms each, a count of 51 guests would require six staff.
If nine more guests arrive to bring the total count to 60, the number of housekeeping staff needed is still only six. The next guest after that will require going to the next “step”, or seven staff.
Costs over the Long Term
An important distinction about the classification relates to the time period being discussed. An economic maxim is that “in the long run all costs are variable.” In the example, large changes in volume can necessitate adding rooms, or separate registration desks, or additional night staff.
Why Variable Costs Are Important
The goal of a business is to make a profit while providing a product or service. An understanding of costs can help with the decisions needed to make that profit. In the situation of a count of 51 guests, there are comparatively fewer additional costs up to 60.
In this case, it benefits the hotel to add guests, even at a lower rate. This is why hotels can offer discount rates for additional guests. This situation is common for airlines, restaurants, condo-hotels and any service that has a large amount of variable cost.
Converting Variable to Fixed Costs
When a business is growing, it is often better to convert variable to fixed cost. A smaller hotel may pay for laundry at a rate per pound to an outside vendor. As it grows, it may be worth making a one-time purchase of washing machines. If volume is declining, it is best to convert fixed cost into variable.
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