Clear_Hear

Lisa Norman manages production for Clear Hear, a cell phone manufacturer. She has received an offer for 100,000 Alpha model cell phones. Although Clear Hear is capable of producing the cell phones, the deal may prove too costly to accept. Big Box, the company who wishes to purchase the cell phones, refuses to pay more than $15 per unit and it costs Clear Hear $20 to make the Alpha model. Lisa’s bonus is based on operating at capacity and profitability, and although Lisa has an excess capacity of producing 70,000 Alpha model units, the profitability of these units stand in question. Lisa can convert her Beta model line over to produce the additional 30,000 units needed, but in doing so, she would lose an additional $5 profit per phone. Lisa has a third alternative solution as well, a reputable OEM (Original Equipment Manufacturer) has offered to sell phones to Clear Hear for $14 and is capable of producing all 100,000 units needed in a timely fashion. Although this alternative sounds appealing, Clear Hears’ value statements indicate Clear Hear employees should be kept working and hiring another manufacturer to produce cell phones will take work away from Clear Hear employees. This paper will cover a proposal for increasing Clear Hears’ revenue, achieving ideal production levels, adjusting fixed and variable costs to maximize profit and identifying methods to reduce costs, so Clear Hear may accept Big Box’s offer without taking a loss. Increasing Revenue To increase revenue, Lisa could look to the R&D department for suggestions to increase production or for new features to add, which might distinguish the Clear Hear phone from other phones allowing them to be sold at a higher rate. Big Box has requested 100,000 phones, which are “nearly identical” to the Alpha Model, this may mean there are features or technologies on this particular phone, which aren’t necessary to seal the deal. Without the added features or technology, production of this new line may be quicker; allowing Clear Hear to produce all 100,000 units, and Lisa’s variable cost per unit may lower, allowing her to sell the phone at the $15 rate and increase her revenue. Achieving Ideal Production Levels Lisa has been allowing production to fall below capacity, which has kept Clear Hear from realizing its’ maximum profit potential. If Lisa were to produce at capacity, using the least cost rule, she would maximize unit production per employee while minimizing her cost. This would enable her to lower prices while making a profit. Lisa’s production level will be ideal when her “marginal resource price of labor equals the price of labor and the marginal resource price of capital equals the price of capital” (McConnell, Brue, & Flynn, 2009, p. 267). Presuming Lisa has determined the maximum unit production possible for the Alpha line would be 70,000 units over the next three months; Lisa must determine if switching the Beta line over to Alpha model production for the remaining 30,000 units is a good business decision. To make this decision, Lisa should calculate the marginal cost associated with producing the extra units. By calculating the marginal cost of producing the extra units, Lisa will be able to pinpoint when marginal cost (MC) begins to exceed marginal revenue (MR) per unit; when she reaches this point in production the law of diminishing returns has taken affect and production is no longer profitable. Adjusting Fixed and Variable Costs A fixed cost is “a cost that remains constant, regardless of any change in a company’s activity” (Fixed Cost, 2009, para.1), a variable cost changes proportionally with the company’s activity or business (Variable Cost, 2009, para.1). The law of diminishing returns applies to variable costs as well as production. The law of diminishing returns is “the tendency for a continuing application of effort or skill toward a particular project or goal to decline in effectiveness after a certain level of result has been achieved” (Law of Diminishing Returns, 2009). Production of each unit affects variable costs, the more units produced, the more costs rise. However, increases in cost are not equal with each unit produced; increases can come in either lesser or larger amounts as production continues. Lisa will want to look at her total-cost data to determine the point in which total variable cost begins to rise by increasing instead of decreasing amounts. At this point, the law of diminishing returns has set in, and it is not cost effective to continue production. Lisa will want to ensure her total cost (total fixed cost + total variable cost) does not exceed her total revenue. If total cost should exceed total revenue, Clear Hear will take a loss on these units. Identifying Methods to reduce Costs As fixed costs remain constant, Lisa has no control over them and must work toward lowering her variable costs; to achieve equilibrium with the offered price. Variable costs include (but are not limited to) supplies, shipping, labor, and utilities. Employing the least cost method as mentioned above will help Lisa determine if her employee count is within acceptable limits. If Clear Hears’ marginal resource cost is too high, Lisa can reduce variable costs by laying-off excess employees. By doing this, Lisa will have followed the rule for employing resources: MRP=MRC (marginal revenue product=marginal resource cost) (McConnell, Brue, & Flynn, 2009, p. 255). Lisa can lessen supply cost by finding cheaper supplies from a new vendor or by receiving a discount for purchasing supplies in bulk. Furthermore, Lisa might be able to find a cheaper method for shipping products than the method she is currently employing. Conclusion Assumptions/Recommendations After reading the Clear Hear scenario, I made the following assumptions; 1) Clear Hear appears to be a company who believes valuing their employees, business partners, and customers, will return value (in the form of hard work, profit, and business) to them, 2) their value statements do not discuss profit or production, but rather keeping employees working, providing for clients, and taking care of business partners, 3) they are a purely competitive firm; other firms such as OEM are capable of producing a similar product and if Clear Hear does not accept Big Box’s offer, Big Box can take their offer somewhere else, which makes Clear Hear a price taker and not a price maker. I recommend that Lisa adhere to Clear Hears values and base her decision on the information she has gathered to determine how she can accept the deal with Big Box without taking a loss. To follow the second value, providing customers with timely products that meet or exceed their expectations, Lisa will need to know what features Big Box wants on their phones. This information may help Clear Hear produce more phones more cheaply. If Big Box does not want all the features Clear Hears’ alpha model possesses, Clear Hear can leave off the extra technology, which will lower variable costs per unit on the Alpha model. Leaving additional features off the Alpha model will save time allowing employees to produce more units. If Clear Hear can gain enough time to produce the additional 30,000 units, she has also complied with Clear Hears’ first value to keep employees working. Should Big Box want all the features the Alpha model currently has, Lisa will need to determine other ways to minimize her variable costs to allow Clear Hear to keep total cost from exceeding total revenue. Should Lisa not be able to produce all 100,000 units from the Alpha model line, she should check her marginal cost data to decide if producing the remaining units through the Beta model line will be cost effective. If the Beta line will produce units at a loss, she should follow Clear Hears’ third value and ask her business partner, OEM, to produce the additional units for the Big Box order. By including OEM in the deal Lisa will secure a $1 per unit profit for all units OEM produces, which will increase Clear Hears’ profit by $30,000. References McConnell, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics; Principles, problems and policies (18th ed.). New York, NY: McGraw-Hill/Irwin. Fixed Cost. (2009). Retrieved December 26, 2009, from http://www.investopedia.com/terms/f/fixedcost.asp Variable Cost. (2009). Retrieved December 26, 2009, from http://www.investopedia.com/terms/v/variablecost.asp Law of Diminishing Returns. (2009). Retrieved December 26, 2009, from, http://www.answers.com/topic/law-of-diminishing-returns