A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience (a visual cycle of over investment, overcapacity, and the price war/weaknesses).
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. |
must include indicators of new capacity being added in the industry.
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. |
The early warning systems for a capital intensive industry must include indicators of new capacity being added in the industry for it to be a successful early warning system. This is important because capital intensive companies are faced with different problems including capacity and over building.
Preparing for a downturn starts in good times. You can prepare in many ways including having cash stacked away so when a bad time comes, you’re company is in a good position. If you are in a good position, you can take advantage of other company’s suffering from the downturn; look for assets at discounts and look for talented employees out of work.
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.
a cost that varies. a cost that a company can reduce or eliminate when a downturn comes.
a cost that is fixed in the short term, it does not change. in a downturn a company cannot change the cost
examples: interest payments on loans and insurance payments
when equipment, tools, machinery, and buildings deteriorate /wear out
machinery and equipment being replaced by better/more effective ways of producing goods and services
Describe the characteristics of the following events briefly.
The Russian war in Ukraine has significantly impacted the oil supply due to sanctions on Russian Oil. The led to a reduction in production of oil, resulting in high demand and low supply. The pandemic caused the demand for oil to drastically decrease which led to a decrease in oil production. When restrictions started to loosen and consumers were comfortable traveling again, the demand significantly increased outmatching the supply. This increase in demand and low supply resulted in increased prices.