A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience (vicious cycles of over investment over capacity causing price weakness).
Capital-intensive industry’s are different because due to their different characteristics they are different to many different cycles to national economy. Capital-intensive industry’s are often subject to long lead on expansion that require a lot of capital to get started. While the long lead times may drive people away slow rates of depreciation can make it quiet profitable when a industry is at the top of the cycle. One major way capital intensive industries are different is during a recession for these companies it is very hard to expenses since the majority of expenses are capital cost. Requiring companies to have high financing and to be ready for large losses during bad times. Industries that are not so capital intensive have an advantage since they can cut more variable cost during time at the bottom of the cycle. Capital expenditures for Capital Intensive business can be used to lower operating cost but, can lower flexibility. When investing companies should add capacity when market is strong and at the beginning of expansion. Investing when expansion growth is declining can cause a massive increase in capacity between companies driving prices and profits down. Other times the price is pushed up due to large increases in industry capcity. Many times companies get caught up in this causing them to become bankrupt.
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 companies require companies to recognize their industry capital intensity. In doing this it requires a manager to know the measure of new capacity coming on line in its industry. This will help a company determine were there industry is in the cycle. Managers can determine this through industry sources such as the news were experienced observers will easily point out over investment. Industry source overall will let a manager know when capacity is being added in their industry.
Capital Intensive industry’s need to first recognize their industry capital intensity. Determining how long expansion usually average is very important in determining when to make investments. This puts a major importance on knowing how long expansion will be over when a down turn will occur. Capacity should only be added to a company when expansions expected to continue. Companies that invest early in an expansion are better off and those who invest late are at risk of going into bankruptcy. Once companies start to announce expansion plans this is when you should stop adding capacity and collect profits as further investment could set a company up with too much capacity and possibly bankruptcy.
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 business are overall are different from less capital intensive businesses. Capital intensive business is vulnerable to profit killing cycles that are due to overbuilding at the end of expansion. Managers in capital intensive businesses need to know industry level of capital investment and monitor it frequently to avoid having to little or too much capital. ## Economic terms
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.
cost that changes based on the amount of sales.
fixed costs: cost that are constant and don’t change based on the amount of output overhead: operating expenses that come with running a business that aren’t used to produce a service or a product. ### Economic Depreciation (page 227) Decrease in the value of an asset overtime due to economic factors. ## Economic events
Describe the characteristics of the following events briefly.
Due to the Russian war in Ukraine there was an interruption of oil supply to the US. This caused capacity to go down increasing the value of oil drastically. US official also placed sanctions against Russia putting a ban on Russian technology for oil and gas exploration and a ban on credits to Russian oil companies and state banks.Essentially US officials are trying to separate ties to Russia as much as possible and hurt them as much as possible in attempts to stop war. While this is bad for Russians for Americans producing oil or other countries this is a great opportunity to fill need capacity and take over as Americans major oil supplier.