Lecture 7: Short term decisions

what are the steps of the decision-making framework

1. define problem/objective

2. identify solution space(scope)

3. identify viable alternatives

4. collect relevant information

5. identify costs and benefits of each option

6. identify highest net benefit option, consider qualitative components here too

7. revaluate decision in hindsight.

What are short term and long term decisions

Short term decisions:

• decisions made under some constraint eg. some costs and inputs are locked in eg. factory size, equipment lease

• rarely implicate future: limited effect on future profitability

  • eg.special orders, make or buy, product mix

Long term decisions:

• decisions made under little to no constraint. pretty much all costs and inputs can be varied.

• likely to implicate the future and have major effect on future profitability

  • eg. long term pricing, outsourcing, activity based management

What are the 2 ways to increase short term profit

1. increase CM by either increasing SP or decreasing VC

• increasing sp too much could reduce demand. could reduce vc by negoitiating raw mat costs or buying in a component

• generally assume fc are comitted in short term so not included in lever

1. Increase quantity produced by increasing capacity utilisation

• can’t change max capacity in short term but can change % utilisation

BE CAREFUL

• don’t scarifice quality by reducing VC. our buy too much stuff externally that you end up creating a new competitor

What are irrelevant costs

• sunk costs: alr incurred and unavoidable

• comitted costs: costs in future that have been alr locked in and can’t be changed

• revenues already earned or promised

• costs that remain identical over multiple alternatives

opportunity cost

value of the next best option not chosen

• eg. if you take time of work to study. accounting will consider student fees, textbooks etc. but doesn’t consider the foregone salary which is opp cost

note: the profit cm foregone by selecting one alternative over another. it is the net return that could be reliased if a resource were put to its next best use.

What are qualitative factors that could tip the decision/could influence short term decisions

• Quality of gs

• Strategy implications

  • Creating future competition

• Reputation

• Customer relationships ie. trust

• Employee morale. 

Accepting or rejecting a special order

• if spare capacity exists, you can do both and not consider fc cuz extra capacity absorbs it.

• if there’s no idle capacity consider estra fixed costs and opp cost

EXCESS CAPACITY

• lowest price you accept is when lowest price= relevant VC

NO EXCESS CAPACITY

• lowest price you accept is relevant VC/unit + extra FC/opp costs

• lowest actual price u accept= VC/unit + cm/unit foregone(as least profitable order) (+extra fc incurred)

QUAL FACTORS TO CONSIDER

• reputational upside

• customer relationship list

• if you need to stop serving a normal customer to do special order

MAKE OR BUY DECISION-refers to short term

• only vc are relevant

• have to consider capacity issues business currently has(ie. will buying extrnal free up capacity that generates more CM)

QUALITATIVE FACTORS

• Quality of external supplied produced

• Reliability of supplier

• Rep impact (what will customers think of you using external supplier)

• Risk of creating competitor

PRODUCT MIX

• Which products should be prioritised eg. cuz limited constraint

NO CONSTRAINT

• Choose one that gives highest CM/unit

  • use relevant vc

CONSTRAINT

• Choose the one that gives you highest CM/unit of the constraint (ie. scarce resource)

  • use relevant vc

QUALITATIVE FACTORS

• How important are deprioritised products

• Will customers stop buying other products from you too

• Could less profitable product become more profitable in future

risks from trying to increase profit

• you may be sacrificing quality which can erode reputation, customer trust, future sales etc

• by outsourcing production to get a lower vc, you may be inadvertently creating a new compeitor

are fc relevant for special orders

no, cuz generally excess capacity absorbs extra costs, but if order costs incremental fixed costs then it becomes relevant

qual factors to consider when accepting a special order

qual factors to consider when considering make or buy

qual factors to consider when considering product mix

why are ppl willing to pay more for long term outsourcing

bc. if you outsource you are able to get rid of some of the fc in the long run