Chapter Opening Questions
A business manager in a capital-intensive industry needs to monitor
its own industry cycles because they routinely experience (cycles of
over investment and prices weakness.
Summary
Why capital-intensive industries are different
- Most capital intensive business have other factors that allow long
lead times on expansion and slow rates of depreciation. In a recession
companies will cut their expenses, however some companies have large
capital costs that aren’t able to be cut. Some business will spend money
on better equipment to lower their operating costs. It takes years but
when times are doog leaders in those industries will build me
capacity.
Elements that make capital-intensive industries prone to
overbuilding:
- high overhead
- long lead time to put new capacity in place
- low rates of depreciation
A hypothetical example illustrating how the cost structure could
induce huge swings in prices and profitability.
| 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. |
The early warning system for capital-intensive industries
- Managers should know how to measure capacity coming on line in its
industry. Listing completion dates and floor area allows to see the
regions total availability both now and in the coming years. estimates
of new capital spending are available from industry sources.
Managing through the industry cycle
- Need to recognize their industries capital intensity. They should
understand the average lengths of expansion in their business. Its good
to also invest in new capacity early in an expansion that will last for
several years. Prices will rise and competitors will announce new
expansion plans. when you accumulate a supply of cash in the bom leaders
will build up new capacity when it’s cheap.
Think contrarian.
| 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. |
Summing up
- Capital-intensive industries are different and are vulnerable to
overbuilding and need additional early warning system that monitors
industry-level capital investment.
Economic terms
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.
Variable Cost (page 222)
- These are costs that change as the quantity of the good or service
of the business changes.
Fixed Cost or Overhead (page 223)
- Costs that are not changeable like rent or constant charges for good
and services.
Economic Depreciation (page 227)
- The gradual decline in economic value of capital stock, nation, or
other entity.
Economic events
Describe the characteristics of the following events briefly.
The case of high oil prices in 2022
- The oil crisis started after the Covid-19 pandemic, much of the
world was facing oil shortages. Because of the covid-19 economic rebound
people started buying gas exponentially and sources began depleting. The
demand surged quicker than companies could get employees hire back and
pump the fuel.