Weird technical interview question
So I got asked this question that I have no idea how to think about.
Can you name a few companies in the high fixed cost business? what are some examples of high variable cost businesses? Is it possible that within the same industry one company can have a high fixed cost and the one will have a high variable cost? Which one is preferable? If revenue increases by 10x at each of these businesse, which of the two - high fc or high vc - will register the biggest increase in margin? Which business would you expect to have higher margins?
I was peeing in my pants
They are just asking you about the concept of operating leverage.
Best to simplify it.
Imagine two very similar businesses that employs tutors that provide private music lessons.
Both charge the same per lesson, do the same number of lessons per week and have the same number of tutors employed but firm 1 pays the tutors a fixed weekly salary (high fixed cost) and firm 2 pays their tutors an amount for each lesson they do (i.e. high variable cost).
As the number of students/lessons goes down firm 1 is in trouble because it has to pay a fixed agreed salary to it's tutors. Firm 2 is ok because less lessons, it pays it's tutors less. On the flip side, if the number of students explodes, firm 1 is happy because salary is fixed and it gets more of the profit (essentially it's fixed cost is being spread over a larger number of students) but firm 2 must pay more as it's tutors are paid per lesson (variable cost).
You could do an example out in excel with actual numbers to get the concept clear. It is a tricky little question and easy to trip you up if you have not thought about it before.
PS some people here seem to confusing capex with fixed costs. Fixed costs are expenses that hit the P&L and impact income, capex does not. Although granted a high capex firm will often have higher fixed costs but not necessarily.
PPS as an interesting aside you may be rightly thinking that as the number of student goes up, the tutors at firm 1 will be doing more lessons for the same pay....you might also have realised that they probably won't be very happy with this and will eventually want a pay rise...this illustrates another important point that in the long run fixed costs can often be variable in nature. Bust that one out in the interview and the accounting nerds on the other side of the table will be nursing a chubby for the duration.