A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience (Capital-intensive sectors over invest in products, like paper, and have price weakness, the business never learns).
All industries go through the cyclical fluctuation of the economy, but capital intensive businesses are more impacted based on their own actions and dynamics of investment that drive swings in profitability and loss in profits during the economic cycle.
Companies cover their costs, including the risk of adjusted return on capital, capital intensive companies has large portions of of cost that are hard to change or lowered. Prolonged periods of unprofitable operation is what happens often for capital-intensive industries. Cycyles are worsened by long lead times for capacity additions and low rates of depreciation.
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. |
Extra elements taken into account include: ways to measure new capacitycoming on line in the industry, timelines are possible with this, estimates of capital spenidng is often available from industry sources, whcih is a benefit to a company. Must watch for over estimation and over investment during times of boom.
Managers and capital-intensive industries need to recognize their industries capital intensity. Business leaders should understand the typical lengths of expansions within their industries. Managers should understand patterns of past business cycles. In times of economic boom, add amassing cash instead of more capacity. And in weaker times, buyout smaller/weaker competitors. 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. |
Capital-intensive businesses face additional problems that most other companies don’t have to worry about. They are vulnerable to profit killing cycles of overbuilding, and need addtional steps to an early warning system., that monitors capital investment in the industry.
Explan 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.
Costs that can be eliminated by cutting production, which may include labor costs, raw materials and energy. ### Fixed Cost or Overhead (page 223) Interest and depreciation, insurance, and administrative staff expenses, thiungs taht are fixed and will not change. ### Economic Depreciation (page 227) Both physical wearing out of equipment as well as obsolescense. ## Economic events
Describe the characteristics of the following events briefly.
The oil mining has slowed in many places and we have seen record prices over the last several months in oil and gasoline, and the major companies do not have any competitors, which means that they can sell as high as they want, they should be aware when other companies join in, as their boom will lower and will drop in revenue fast.