Microsoft Cost Structure
The fixed costs are the business costs that do not change (they remain the same) in total but vary for every unit when the volume of production changes. The facility-level costs, for instance, depreciation, rent, salary, property taxes and insurance are some examples of fixed costs. The variable costs, on the other hand, changes in different proportions to the changes in the volume of production. The variable costs increases in direct proportion to volumetric change as the production increases. Likewise, as the production decreases, the variable costs also reduce in direct proportion.
Analysing the variable costs and fixed costs of Microsoft Corporation gives us the operating leverage. Companies that tend to have high operating leverages are the companies that have high proportions of the fixed operating costs in connection with the variable operating costs. It means that the company uses a lot of fixed assets as a base of operation. Conversely, the companies that operate in low fixed assets have low operating leverage in connection with the variable operating costs. The bulk of Microsoft cost structure is fixed. The cost is also limited to marketing costs and development. Whether Microsoft sells one copy or over 100 million copies of the latest Windows 10 software, the company costs remain the same. Once Microsoft sells enough copies of its software to cover for all its fixed costs, the additional sales are basically profits. This means that Microsoft has a high operating leverage.
Figure 1: Microsoft Fixed Cost Trends and Behavior
Microsoft is a monopoly. Even a monopolist cannot set overly-exorbitant prices and make good sales. The real-world transactions are, therefore, never infinitely high. Microsoft when deciding to set prices for its software and other products, must consider the tradeoff between two factors; setting a higher price leads to increase in every sold unit, however, a higher price will contribute to a decrease/ reduction in the number of units sold due to a decrease in the consumer demand and the other suppliers are likely to release better and cheaper version of the product. It is therefore in the best interest of Microsoft as a monopoly to maximize their profits when there is a significant balance between the following two factors; the direct revenues gain obtained from higher prices charged on windows would be offset by the lost net revenue because of the reduction in volume caused by higher pricing.
In several occasions as in the case of Microsoft, the demand for one product leads to the demand for another product. For example, people who do not have personal computers do not require an operating system. On the other hand, the people who have computers require the operating system. The demand for Microsoft Windows 10 therefore directly depends on the demand for computers.
Short-run versus long-run dynamics for Microsoft Corporation
The short run and the long run can be defined in the market dynamics. In the short run a company already have chosen whether to do business and at what scale and the intended production technology. Therefore, the number of companies in a given sector is fixed in the short run, and the firms already in the market are making the decision about how much to produce. In the long run, on the other hand, the companies have the flexibility to enter or exit fully from an industry, since they have the power to choose whether they will renew or incur the initial fixed costs of staying or existing from the business in an industry in the long run.
The long run and the short run can therefore be differentiated in terms of the market dynamics as follows:
• For short run, the number of companies in a given sector (even though companies can close their shops and produce zero quantity)
• For the long run, the number of companies in a given sector varies since the company can exit or enter the market.
Microsoft has its fixed costs covered. It can therefore only enter a market where the variable costs can be covered. Microsoft can, therefore, enter the short run market. In the long run, the firm can enter the market if there is a high enough market price to result in negative economic profits.
Microsoft Corporation (MSFT) fixed costs and variable costs based on the Income Statements for the three latest years (see figure 2)
Figure 2: Microsoft Income Statement period 2012 to 2014 (Source Yahoo Finance)
The variable costs are the operational costs including research development, non-recurring costs, selling general and administrative. The fixed costs of Microsoft include income expenses, earnings before taxes and interest, income tax expense and income before tax expenses. As observed from the income statement over the three year periods, the fixed costs are much higher as compared to the variable costs. This justifies the earlier statement that the company has a high leverage.
Ability to Change to the Ever-Changing Market Conditions
Microsoft has what it takes to keep up with the pace of the ever-changing business environment. The software is one of the top global competitive and prone to change sectors. The company has heavily invested in research and development (see the income statement), people skills and the assets. Microsoft also has the capacity and resources to fund changes and beat the competition. Being almost a perfect monopoly, it means that Microsoft has the best chance to change alongside the changing market conditions. The high-profit margin makes Microsoft more liquid in terms of cash and assets and it can, therefore, diversify to other areas of production.