A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience cycles of price wars, over-capacity and over-investments.
Capital-intensive industries are different because they are more susceptible to ending up in situations of over-investments which will end up in the long term having operations that will not be profitable.
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. |
Early warning system for capital-intensive industries must have indicators for new capacities for the industry overall.
Managing through the industry cycle is important for managers because they have to understand what is being focused on throughout the cycles of economic booms and downturns especially.
| 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. |
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 is costs that can be eliminated from when production gets cut
Fixed costs in a short-term are considered overhead, if a price exceeds the market price it runs if it is exactly the market price it won’t cover overhead but will still run its operation.
Economic depreciation considers both physical and obsolescence for equipment.
Describe the characteristics of the following events briefly.
The case of the high oil prices stemmed from a conflict between Russia and Ukraine. Russia had put a stop towards exporting oil to other countries. Due to this the United States could not produce enough oil to keep afloat as they were previously when importing it from Russia. However the United States still imports oil from other countries, but due to the war it caused oil prices to skyrocket almost $5 in some states for a while, and we are still coming down from insanely high gas prices.