Revenue,_Cost_Concepts,_and_Market_Structure

Running head: REVENUE, COST CONCEPTS, AND MARKET STRUCTURE Revenue, Cost Concepts, and Market Structure Proposal ECO/561 April 26, 2010 Revenue, Cost Concepts, and Market Structure Proposal Clear Hear scenario Clear Hear Corporation is a cell phone manufacturing company (University Of Phoenix, 2008). The company produces two kinds of cell phones for market: the Alpha model and the Beta model. Kendra Sherman is a business development specialist; she has secured an order from a large chain company called Big Box for 100,000 cell phones. Big Box needs the phones for a service promotion the company is running with a telephone service provider. The cell phones ordered are similar to the Alpha model, and Big Box is not willing to pay over $15 per cell phone ordered (University Of Phoenix, 2008). Clear Hear produces the Alpha model for $25 per phone. The company would lose five dollars selling price per phone if it accepts the order, but the company would produce more phones provided the company accepts the deal. Producing the phones would fulfill the company’s statement of values; “Keep our employees working, provide our customers with products on time and which reliably meet or exceed expectations, and treat our business partners the same as we want to be treated (University Of Phoenix, 2008).” In this scenario, let us start with evaluating various alternatives in front of the company. Lisa and Kendra have three options. • To accept the order, manufacture 70,000 units by utilizing the excess capacity, and outsource 30,000 units to the OEM. • Outsource the manufacturing of 100,000 units to the OEM. • Manufacture 100,000 units in house by utilizing spare capacity as well as switching production capacity of the beta model to the Alpha model. Now, let us evaluate the pros and cons of each of these alternatives. The first alternative of utilizing spare capacity of 70,000 units and outsourcing remaining requirement to OEM does not suit the company as recent cost data shows that company's in house cost for producing such units is $17/unit, which is above the $15 pricing offered by the buyer. Hence, it does not make economic sense for the company to operate the unit at a loss. In such short run, it is nearly impossible for the company to bring down the cost of production equal or below $15. Therefore, it is not advisable to operate at full capacity by sustaining losses. In the end, if the company is able to bring down costs, such opportunities can be tapped by utilizing excess in-house capabilities. The second alternative of outsourcing the complete production of 100,000 units to OEM is surely attractive as company will be able to fulfill the order and make a profit of $1/unit or $100,000 in profits without disturbing its existing manufacturing system. However, one of the major concerns in this scenario will be quality issue with the OEM. Although OEM maintains a good reputation, company will need to keep a strict control over the product quality delivered by the OEM to ensure that the product delivered to the customer does not jeopardize company's reputation. Although this alternative puts a question mark on the values of the company to keep their employees working, it is indeed beneficial for the stakeholders of the organization as it is resulting in excess profits. However, we have to assume that the OEM adheres to same set of quality standards as the company has been adhering to and delivers excellent products. The third alternative of running the plant at full capacity and fulfilling the requirement of excess demand of 30,000 units by transferring capacity from beta model does not make economic sense as the opportunity cost of such switching of models is too high. Beta model is highly profitable and it does not make sense for the company to switch production from a highly profitable model to a loss-making model, just to maintain 100 percent capacity. Now, let us evaluate the risks associated with various alternatives. If the company sticks to the first alternative, it will bear huge losses if it is unable to bring down fixed and variable costs. Further, if production will take place at two places (in house and outsourced at OEM), quality issues may occur. This method is feasible only when company restructures its cost structure and attains cost reduction in such a short run, which may not appear feasible. The third option also carries significant risk on the same premises as inability to bring down costs will not only result in losses, but the company will also lose opportunity to make higher profit on beta models. In my opinion, the company should grab the opportunity to supply this order by outsourcing it to OEM. It will not only help the company in capturing profits of $100,000 dollars in the short term, but will also provide an opportunity to the company to understand the cost structure of OEM and reduce its own in house cost of producing alpha model by significantly reducing fixed costs, overheads and variable costs. Company can launch a reengineering and quality management program to attain such objectives. Although there will be risks related to quality, company can pay extra attention to OEM's quality initiatives to ensure that the delivered product is of highest quality. The profit generated by choosing this option will be invested in reengineering initiatives to bring down costs of production and achieving organizational values of operating plant at full capacity. Reference: Week four-class note. Message posted to http://University of Phoenix class forum Eco/561 Economics course website