Fixed Cost Degression

Fixed cost degression describes the fall in fixed costs per unit as the quantity produced or sold increases. Arithmetically, fixed costs per unit equal total fixed costs divided by volume, so the amount falls as volume grows without anything changing in the fixed costs themselves. A business with 2 million euros of fixed costs bears 40 euros per unit at 50,000 units and only 25 euros at 80,000. Fixed costs typically include rent, depreciation, insurance, administration and a substantial part of personnel costs, while materials and freight grow with volume.

The effect works in both directions: as utilisation falls, unit costs rise just as quickly, which is why companies with a high fixed cost share lose margin disproportionately in a downturn. That sensitivity is the real point in diligence, because it determines how much debt a structure can carry. The term should be distinguished from economies of scale, which have their own entry in this glossary and cover, beyond mere spreading, advantages in purchasing, utilisation and specialisation. Fixed cost degression is therefore one component of economies of scale but not the whole of them.

It is limited by capacity: once a plant is fully utilised, additional volume requires new investment that raises fixed costs in a step. Such step costs have to be shown separately in forecasts, because a linear extrapolation would otherwise imply a margin path that is technically unattainable. Diligence therefore regularly requires the cost base to be split into fixed, step-fixed and variable components, since only that shows at what fall in revenue earnings tip over. For valuation it follows that companies with a high fixed cost share earn above average in good years and lose disproportionately in weak ones.