A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience ( visual cycle of over investment, overcapacity, and the price swings ).
Elements that make capital-intensive industries prone to overbuilding:
A hypothetical example illustrating how the cost structure could induce huge swings in prices and profitability.
| mining company (VC = $25/ton, FC = $20/ton) | strawberry importing company (VC = $40/pound, FC = $5/pound) | |
|---|---|---|
| When the price is above $45 | keep producing because it is profitable | keep producing because it is profitable |
| When the price dips below $45 in a downturn | Little change to production. There is little flexibility because much of the cost is fixed. The company keeps operating as long as the price is not lower than VC, $25. | Decreased production. The company is flexible because much of the cost is variable. For example, it can cut production with layoffs. |
Capital-intensive industries must be aware of when to expand on capacity and when other industries in the same field are expanding on capacity as well. Also being aware of overinvestment is key to navigating a capital-intensive industry.
Think contrarian.
| A manager should: | |
|---|---|
| When prices rise and competitors announce new expansion plans | Stop adding new capacity. Sock away cash and wait for the industry’s over-expansion to play out. |
| When writers gather up all the bad news at the bottom of the market | Pick up new capacity as troubled competitors offer up equipment and facilities at discounts. Do not move too quickly and wait for real distress by monitoring the financial conditions of weak competitors. |
Having a successful early warning system that keeps track of capital investments can help capital-intensive companies from collapsing.
Explain each of the following terms in your own words. The author explains the terms in the textbook. If necessary, you may also Google the term on the Web. Good resources include:
Explain the terms in your own words briefly.
Expense that varies due to the amount of production.
Costs that stay constant even when the amount of production varies.
The decline of an asset overtime due to the use of that asset such as machinery.
Describe the characteristics of the following events briefly.
From the Pandemic that dropped oil prices well below $2.00 to Russia invading Ukraine that increased oil well over $5.00 in some states, 2022 did not have a great start to the price of oil. The price of oil increased which then increased the price per gallon for Americans. A solution to this problem was to produce more oil in the country so the prices at the gas pump could decline. This solution did not follow through probably because of the environmental consequences. The push for a greener country is now coming with a price for Americans and it is a price that is too high. If the prices of oil from other countries are expensive, then it is time to take the matters into our own hands and produce more oil for the country regardless of what it will do to the environment.