Revenue,_Cost_Concepts,_and_Market_Structure_Proposal_Paper

Revenue, Cost Concepts, and Market Structure Proposal Paper Travis B. Taylor University of Phoenix ECO/561 Maria H. Ramjerdi September 6, 2010 To:   Clear Hear, President and CEO From:     Chief Economist Staff Analyst Subject:   Clear Hear – Market Structure Proposal -------------------------------------------------------------------------------------------------------------------- The economic analysts here at Clear Water are very much aware of the current problem of operating the product line we have in-house and manufactured on-site at full capacity. In addition, the staff is aware as well of the of the customer relationship problems the company has with Big Box at this current time. Before presenting a proposal intended to resolve these issues we took into consideration the company runs two product lines in the factory. We took into consideration as well that this is a fast-moving manufacturing company that sets high values and standards for itself and its leadership. Our Business Development Specialist Kendra Sherman is meeting with the company’s production manager Lisa Norman to discuss an order she received for 100,000 cells phones identical to Clear Hear’s alpha model. Ms. Sherman has made it known that the order is intended to support a current order that our largest customer, Big Box, is making with a telephone service provider their customer. Therefore, this company will need to make some decisions. I am sure you are aware with any big deal, there are almost always stipulations. The company has been provided with a delivery date of 90 days by Big Box. Ms. Norman seems to be most interested by the fact she will be able to use the excess capacity of 70,000 units. However, we know that Ms. Norman’s bonus is based on keeping the factory running at full capacity. Profitability is the basis for the largest part of her bonus. Therefore, because Big Box is only willing to pay $15 per cell phone Ms. Norman should be concerned with profitability. We usually see the Alpha model sell for $6 per unit more than the $20 per unit price the model has. The Beta model costs more to produce than the Alpha model and sells for $30. The Original Equipment Manufacturer (OEM) was the other option that needs to be taken into consideration. The OEM has vast experience concerning manufacturing cell phones for many of the other leading brands. Ms. Norman recently previewed a prototype of the Alpha model from OEM. OEM has stated to Ms Norman that they can produce these units within a short period and that these units will have identical performance to the Alpha model. If OEM were to produce the units then Clear Hear will not have to. Therefore, three different alternatives have been developed because of what both Ms. Sherman and Ms. Norman have experienced. 1. Clear Hear will produce the number of cell phones required by Big Box. To complete the order in the allotted time Ms. Norman would use 70,000 units of the Alpha model that are excess capacity and switch 30,000 units of the Beta model to finish off the order. However, it has been indicated that to sell the phones to Big Box would result in a loss of $350,000 for Clear Hear. Furthermore, additional indications have the opportunity cost for this order calculated at $450,000, which would mean a total economic loss to company of $800,000. 2. Clear Hear allows OEM production of the 100,000 units at $14 a unit and then sold to Big Box for $15. This course of action would create a $1 per unit profit. The fixed cost associated with each individual unit of production needs to be taken into account because variable cost is not calculated into the profits of the company. However, after calculating in each of the fixed costs, the economic loss would again be $800,000. 3. Clear Hear declines the order from Big Box and doesn’t run at full capacity. However, by taking this course of action the company will not gain any profit. When taking each of the three options into consideration, the first option would be to decline the offer of manufacturing the cell phones because of the economic loss to the company. Again, the second option would have the company manufacturing cell phones at a big economic loss. However, the second option would allow the plant to operate at full capacity and allow everyone within the company to remain employed. In addition, the second option allows the company to develop a business relationship with a major chain. The third and final option has Clear Hear collaborating with OEM to manufacture the unit and provides the company with $100,000 in profits that could not be obtained with the first two options. The third option also has the distinction of allowing Clear Hear to collaborate with a major chain that is Big Box. The third option seems to be the one that would be most economically profitable while allowing OEM to manufacturer the initial order. By choosing this option the company can show Big Box that at Clear Hear we stand by our value statement that we can meet promised deadlines while still making a quality product and that we treat our business partners in the same manner as we wish to be treated. With the knowledge that producing our Alpha model can be done at lower costs, we need to develop a plan to cut those costs and lower the price that the company currently charges. Applying smaller amounts of resources such as materials and labor the company could realize lower prices. The company could in the long run adjust the quantities of resources they employ by collaborating or outsourcing with outside vendors that can produce and supply needed material of the same quality but at lower prices. By decreasing cost, one could lower the price of cell phones offered to increase demand. In the end Clear Hear would see a higher profit return with the increase in demand.     The concept of opportunity cost is important to remember and understand. In addition, we should remember that it is that cost, which must be forgone to pursue a certain action or simply put, the benefits you could receive by taking an alternative action. For most cases this would mean a choice between two different options. However, in Clear Hears case there are three options. Knowing the end outcome would make the decision very easy. We needed to perform a cost benefit analysis to determine which risks to take with the options we have. Something else that we should keep in mind is that we should only proceed with something if its benefits outweigh its opportunity cost. The following are ways that economists measure and calculate opportunity cost when making a choice: 1. What alternative opportunities are there' 2. Which is the best of these alternative opportunities' 3. What would I gain if I selected my best alternative opportunity instead of the choice I am considering' The answer to the third question is the opportunity cost of the choice. (Alden, 2005) Activity based costing is another concept used by analysts to help identify the cost drivers of a company. In addition, this concept will help to determine the impact on a company’s variable and fixed costs as they relate to an opportunity cost. The activity based costing concept helps to assign costs to activities and is simpler than the method of cost allocation. It is the cost benefit ratio of those two costs that ultimately affect the bottom line. It is important that we understand this concept as it will help us to know how much it costs to acquire and retain customers. This concept will allow the company to know the exact cost of a specific activity. One of the main goals of short-term financial management is to manage each of the company’s current liabilities (accruals, notes payable, and accounts payable) and current assets (marketable securities, inventory, cash, and accounts receivable) to create a balance between risks that contribute positively to the company’s profitability and value.   Combining current assets and current liabilities into working capital is the best way to look at each of the two. To get the working capital computation you must use current assets minus current liabilities and the result can be negative or positive. The amount of liquid assets the company has to further build on itself, produce shareholder value, and fund growth is due to working capital. We hope there will be a positive outcome for all involved and believe you will be pleased with the recommendations and analysis of this market structure report. We wish to thank you for reviewing our proposals and the process we used to arrive at the choices we made. Reference Alden, L. (2005). Opportunity cost: a primer. Retrieved from http://www.econoclass.com/opportunitycost.html