A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience a cycle of over investment. Leading to large swings in profit.
Capital-intensive companies are extraordinarily vulnerable to overbuilding during times of financial promise. This means they must also include an industrial-level capital investment monoriting system.
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 cost that changes based on volume.
Fixed and overhead costs are costs that can not be easily manipulated or avoided.
Economic depreciation is the inherent loss in value of an asset over time.
Describe the characteristics of the following events briefly.
The case of high oil prices in 2022 is a perfect example of how controlling the supply can artificially increase the demand and in tern the price. After Russia invaded Ukraine, the majority of countries stopped importing Russian oil.This caused the demand to fall, which was followed by Western oil companies refusing to drill more oil, instead selling the same amount of oil at higher margins.