Understanding Fixed vs Variable Costs as a Founder
To be capital-efficient as a founder (also applicable to life, in general), when evaluating various cost line items or taking on a new cost, have a clear understanding of “Fixed” vs “Variable”. Variable Costs are driven by your intended “velocity” and therefore, can be controlled during tough times via a frugal approach (cut variable marketing spend, let go of expensive contractors etc.). Fixed Costs don’t care about your velocity and will keep eating you up (housing rent/mortgage, office space, full-time salaries etc.). They are much harder to control, given they reflect a certain baseline you have up-leveled your startup (or life) to. Paring down Fixed Costs will require more drastic down-leveling, including completely letting go of certain assets or experiences.
The issue with Bay Area startup environment today is extremely high Fixed Costs (housing, child-care, salaries etc.). These are uncorrelated to the actual state or momentum in your startup so founders have no choice but to live with them. You can’t be frugal with Fixed Costs beyond a point, as they are driven by the external environment, not the choices you make. This, in a nutshell, is the real challenge facing Silicon Valley founders.
Here are some ways to proactively manage your startup’s Fixed Costs at early stages of the Company:
- Explore building a non-Bay Area distributed team — to balance output with salary costs, at least until you see the business momentum required to support Bay Area salaries.
- Be generous with equity, (relatively) tight with cash — I know this is a hard one, especially while hiring engineers in today’s market. But as founders, we need to be disciplined about this. I would rather wait out for the right candidate who believes in aligning incentives with the real situation of the startup. For instance, if someone is asking for high cash compensation in a pre-PMF startup, this means they are not the right fit for this stage. I am all for doubling-down on higher equity, even higher than market standards, for early risk-taking hires. But every $ of cash being paid out needs to have a solid justification. Anyone who seriously wants to join a really early stage startup, needs to understand and appreciate this viewpoint.
- Try converting Fixed Costs into Variable Costs — some ideas could be paying sales people more on % of sales commissions and less on fixed; going for an “on-demand” co-working space with elasticity to quickly scale up/ down; keeping specific functions eg. designers, content writers etc. (these functions need to be chosen really carefully) on contract per “as-needed” basis, instead of full-time etc.
- Be frugal on G&A — optimize costs on office space, service providers, vendors, food etc. In particular, Bay Area startups have a tendency to splurge beyond their means on fancy office spaces, lavish off-sites, dinners at marquee restaurants, expensive swag etc. These non-core costs tend to add up and hit your budget more than you might realize.
- Leverage free ways of brand-building — instead of spending tons of $$ on brand marketing to drive early awareness (eg. conference sponsorships, which are essentially Fixed Costs), leverage free channels such as blogging, building a community on social media (Twitter, LinkedIn, Quora etc.), podcasts, creating a compelling website, white-papers, research articles, invited speaker slots etc. Early stages of a startup are all about cost-efficient marketing. This can only happen when founders focus on the above channels to build their startup’s brand, their personal brands as well as communities around their product. Austen Allred, Co-founder and CEO of Lambda School, is doing this very smartly.
Would love to hear what ways of Fixed Cost management have worked well for your startup.