Module 14, Short-Term Decision Making

Short-Term Business Decisions

Decisions that address a temporary circumstance or an immediate need.

• e.g., Accepting a special production order, determining the best product mix from current products, outsourcing a part or service, further processing or refining a current product, etc.

Long-Term Business Decisions

Decisions that align more with permanent problem-solving and meeting strategic goals.

• e.g., Buying new equipment versus re-modeling old equipment, choosing which products to manufacture, expanding into a new area or country, diversifying by buying another business, etc.

In the context of decision-making, something is relevant if it…

Will influence the decision being made.

Avoidable Costs

Costs that…

• Are always relevant in decision-making.

• Can be eliminated, either in whole or in part, by choosing one alternative over another.

• Includes future costs or revenues that do differ.

Unavoidable Costs

Costs that…

• Are not relevant in decision-making.

• Does not change or go away in the short-run by choosing one alternative over another.

• Includes future costs or revenues that do not differ.

Sunk Costs

Costs that have already been incurred and, therefore, are not relevant because they are unavoidable.

Opportunity Costs

Costs that have been avoided, or revenue given up, by choosing one alternative over another.

Special Orders

Are typically for goods or services at a reduced price and are usually a one-time order that, in the short-run, does not affect normal sales.

When determining whether to accept or reject a special order, management must consider…

• The capacity required to fulfill the special order.

• Whether the price offered by the buyer will cover the cost of producing the products.

• The role of fixed costs in the analysis.

• Qualitative factors.

• Whether the order will violate the Robinson-Patman Act and other fair pricing legislation.

Normal Capacity

The production level a company can achieve without adding additional production resources, such as additional equipment or labour.

Outsourcing Decisions

In which a company must decide whether it is going to make a component that it needs to manufacture a product or buy that component already made.

• e.g., Ford buys truck and automobile seats, as well as many other components and individual parts, from various suppliers and then assembles them at Ford factories.

• Many services, such as payroll, are outsourced.

  • e.g., ADP provides payroll and data processing services to over 650,000 companies worldwide.

Advantages of Outsourcing

• Utilizes external expertise, and removes the need for in-house expertise.

• Frees up capacity for other uses.

• Frees up capital for other uses.

• Allows management to focus on competitive strengths.

• Transfers some production and technological risks to supplier.

Disadvantages of Outsourcing

• Takes away control over quality and timing of production.

• May limit ability to upsize or downsize production.

• May have hidden costs and/or a lack of stability of price.

• May diminish innovation.

• Often makes it difficult to bring the production back in-house once it has been removed.

Segment of a Business

A portion of the business that management believes has sufficient similarities in product lines, geographic locations, or customers to warrant reporting that portion of the company as a distinct part of the entire company.

Historically some of the most difficult decisions that managers make are…

Whether to keep producing a product, whether to continue operating in certain areas, or whether to close entire segments of their operations.

• This is decision is made by comparing contribution margins and fixed costs, and by calculating the total net income for retaining the segment, then comparing it to the total net income for dropping the segment. 

Common Fixed Costs

Fixed costs incurred that are general to the organization as a whole but not directly associated with any one segment.

• e.g., CEO salary, rent, utilities, insurance on corporate headquarters, and salaries of others at corporate headquarters.

• Must be allocated, for financial reporting purposes, in some way to the revenue generating portions (i.e., segments) of the business.

• Managers of the segments have no control over common fixed costs allocated to them. Therefore, they often ignore common fixed costs for decision making purposes.

Decisions on Whether to Sell or Process Further

To determine the point at which to sell their product (i.e., when it is no longer cost effective to continue processing the product before sale).

• e.g., Once milk has been processed it can be sold as milk or it can be processed further into cheese, yogurt, cream, or ice cream.

• A company will compare the revenues from selling the product now to the net revenues (revenues less additional costs to process further) that occur with further processing of the product.

Decisions Regarding Resource Constraint

Many resources (e.g., time, labour, space, and machinery) are limited, therefore constraining the ability of a company to have unlimited productive capacity.

• e.g., A retail store is constrained by the amount of floor space available to display its goods.

• Companies must make decisions on the best ways to allocate their resources in order to maximize the benefit to the firm.

  • This is especially true when a company is operating at capacity or makes multiple products or provides multiple services.