A business manager in a capital-intensive industry needs to monitor its own industry cycles because they routinely experience (Capital-intensive sectors over invest products, such as paper, and they have price weakness because of it, the business never learns).
All industries are all going to go through the cyclclical fluctuation of the economy, but capital intensive businesses are more impacted based on their own actions and dynamics of investment that drive swings in profitability and loss in profits during the economic cycle.
Companies cover their costs, including the risk of adjusted return on capital. Capital intensive companies have tend to have large portions cost which are hard to change raise or lower. Some Prolonged periods of unprofitable operation is what happens often for capital intensive industries. Cycles are worsened by long lead times for capacity additions and low rates for depreciation.
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. |
Extra elements taken into account for this early warning system is: Ways to measure new capacity coming on line in the industry, with this ongoing timelines are possible. Estimates of capital spending are often available from industry stories and is a benefit for the company. You must watch for over estimation/investment during times of boom.
Managers and capital intensive industries would be best off recognize their industries capital intensity Business leaders should understand the typical lengths of expansions within their industries. managers also should understand patterns of past business cycles. In times of economic boom, add amassing cash instead of more capacity. In weaker times you should buyout smaller and or weaker competitors. 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. |
A capital intensive business may face additional problems that most others don’t have to worry about. These companies are vulnerable to profit killing cycles of overbuilding. Because of this they need additional steps to an early warning system., This must monitor capital investments in the industry.
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.
Costs that can be eliminated by cutting produstion, which may include labor costs, raw materials and energy.
Interest and depreciation, insurance, and administrative staff expenses, things that are fixed and will not change.
Both physical wearing out of equipment as well as obsolescence. ## Economic events
Describe the characteristics of the following events briefly.
The oil mining industry has slowed in many places also we have seen record prices over the last several months in oil and gas the major companies don’t have many competitors and so they can sell as high or as low a price which they desire. They would be wise to be aware of new companies that join in because their boom will therein lower and they will have a substantial drop in revenue and fast.