A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience a viscous cycle of over investment, overcapacity, and the price worth. There’s wide swings in the market price of the products and the profitability in capital-intensive industries.
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. |
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. |
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.
*A variable cost is a corporate expense that changes according to how much a company produces or sells. Variable costs can increase or decrease, and this depends on the company’s production or sales volume, if production increases then the costs rise, and if the production decreases, the price falls.
*Fixed costs are costs that do not vary with the amount produced. Examples of fixed costs are interest on debt and rent. Fixed costs are usually based on time rather than the quantity produced or sold by a business.
*Economic depreciation is a measure of the decrease in the market value of an asset over time from influential economic factors. Economic depreciation can be important for asset owners seeking to sell an asset in the open market.
Describe the characteristics of the following events briefly.
When Russia decided to invade Ukraine, the oil prices shot up. The war in Ukraine has drastically interrupted the oil supply, including sanctions against Russia. When Russia first invaded Ukraine, the oil prices skyrocketed from $76 per barrel to over $110 per barrel in March 2022. The oil prices are so high because the Organization of the Petroleum Exporting Countries agreed to reduce the production target by about 2 million barrels a day. Analysts expect the prices to stay high throughout the rest of 2022, but we have to wait and see what happens in Ukraine.