And it becomes extremely vital to survive and then thrive in a difficult economic time. And it’s the difference between fixed costs and variable costs. So, fixed costs would be like rent. No matter how many people are in your office building, you still have to pay the rent. One person shows up, 100 people show up, the rent amount is still the same. That’s an example of a fixed cost. An industry with a lot of fixed costs is like the airline industry. And right now, they’re struggling quite a bit because, even though there are no passengers flying on the airplanes, they still have to make the loan payments on those airplanes. So, it’s a very difficult business. It’s very difficult to survive and thrive in a down market when your cost structure is high and fixed.
Hi, it’s Victor Cheng from SaasCEO.com. And today, I want to talk to you about being prepared for a possible recession. Back in 2008 and 2009, you might recall, there was a great economic crisis, globally, called the Great Recession. And I was not spared in that recession by any means. In fact, my business had declined by 100% in revenues at the start of that particular recession.
So, in my moment of panic, I decided to go back to my roots and do homework and figure out what other companies did in all the prior recessions and depressions. And at that time, people were panicked. They thought it was the end of the economic world. And so, I spent some time really digging through the last 136 years of economic data in the United States economy, looking at the last 12 recessions and depressions to figure out, “Did anyone make it work?” And what I found was quite surprising.
Despite the fact that, in the majority of our history, we’ve had more economic expansion years than recessionary years, two-thirds to three-quarters of Fortune 500 companies were actually started during a recession or a depression. I thought that was quite fascinating. So, I wrote my findings in a book called The Recession-Proof Business. And what I want to do is share some of my insights from that research and from my experience in working with clients over the last 20 to 30 years.
So, today’s topic is really about cost flexibility. Before you can thrive in a recessionary environment, you have to survive, right? And one of the keys to survival is profitability and positive cash flow. And specifically, I want to talk about cost flexibility. In times of economic uncertainty, you don’t know what’s going to happen to market demand. We’ll talk more about how market demand shifts quite significantly in a down economy and how to take advantage of that. But for today, I want to talk about being flexible on cost. And specifically, I want to introduce two key concepts that most CFOs are quite familiar with, but not all founders of SaaS companies are familiar with.
The other cost type is a variable cost. And a variable cost is a cost that fluctuates and scales proportionally with your revenues. So, a simple example of a variable cost is sales commissions. If your sales double, you pay twice as much in sales commissions. If your sales dropped by 50%, the amount you pay for sales commissions drops by 50%.
In a recessionary environment, you want to shift as many of your costs to be more variable than fixed. And even if you had to pay a little extra, it is worth having the flexibility in a down market. So, a simple example around real estate: You can rent an office building and get a 10-year lease. That’s an example of a fixed cost. A better approach, if you can get these terms, would be to get a one-year lease with 10 one-year renewals where you get to choose to renew and if you say yes, the landlord has to agree. Now, on a per-square-foot or per-square-meter basis, depending on where you are in the world, you probably have to pay more for such flexibility. And in a recessionary environment, it is worth paying a little extra to have flexibility.
Another example would be contractors. Rather than hiring new employees, if you’re in an area of growth, you might consider hiring contractors or consultants who are on short-term contracts because you don’t know how much you’re going to need them. And so, as you grow, you can keep adding and extending those contracts. And if for some reason the market shifts and something happens, and the business has to contract quite suddenly, you simply just don’t renew those contracts. So, the key message here is, in an uncertain or negative economic environment, you want cost flexibility. And the key is to have more of your costs be variable than fixed.
So, that’s my point for today, I want you to think about that. Look at your cost, and what portion of your costs are fixed vs. variable. And can any of them be moved from one category to the other, specifically, from fixed to variable? So, those are the things you want to keep in mind as this particular economic environment unfolds. And until next time, good luck, and I’ll see you in the next video. Thanks.
Stay tuned for my upcoming videos on how to take advantage of shifts in market demand. Usually, in a down market and in a recession, the amount of spending in the economy shrinks only by a little bit. What’s more significant is how the spending pattern within the economy changes quite dramatically. And so, the key is to take advantage of those changes. And we’ll talk about that in a future video. Thanks, and have a great day.