The Meetoo Company: Cost Structure & Production Process Analysis

Questions:

a)In a production process, there are chiefly two types of costs. These are average fixed costs (AFC) and average variable costs (AVC). The amount of variable costs varies as the production process will continue its production system (Salas-Molina et al. 2017). On the other hand, the fixed cost remains constant for a particular time (Porter and Heppelmann 2014). If a company stops its production process, the variable cost will be zero. However, the fixed cost cannot be zero and the producer will have to bear this cost for a particular time being. However, this situation happens in the short-run. The total production cost of a company includes both average variable costs and average fixed costs. Hence, to take any decision regarding the cost structure of a company, these two costs should be considered with equal importance.

The selling price of each shirt is £15. However, the cost price is £18. The average fixed cost is £4 and the average variable cost is £14. Hence, from this cost structure, it can be said that the company should further produce shirts. As the selling price of each shirt is greater than its average variable cost, the company can bear the whole variable cost of the production. Moreover, after paying variable costs, the company will have £ (15-14) = £1 as excess. By this amount, the company can compensate a small portion of its fixed cost. The remaining portion of fixed cost will be paid by the producer from his or her income. The amount of remaining fixed cost will be £ (4-1) = £3.

On the other hand, if the company will close its factory then there will be some other effects. The decision of Mike Smart to shut the factory will adversely affect this Meetoo Company. When the company will shut its Singapore factory, the production process will be stopped. Hence, no shirt will be produced and the company will further loose the opportunity to sell its shirt in the market. As a result, the company will not receive any revenue. However, the fixed cost and variable cost of this production process will remain same, for a fixed time. As the company will not earn any revenue, these costs will be paid by the producers from their own profits. This total amount of cost, which the producer will bear, is £18. However, this is not desirable for any producer.

Hence, it will be beneficial for this company to continue its production process. As £3 is less than £18, the producer of the Meetoo Company will get advantage by continuing its production process. Hence, Mike Smart’s advice to shut the Singapore factory is not economically appropriate.

Answers:

On the other hand, the advice of Smart will be economically appropriate if the selling price of each shirt will be less than its average variable cost. In this situation, the producer will not bear its average variable cost and average fixed cost. Furthermore, the amount of variable cost will remain same if this production system will continue. Hence, it will be better to shut this factory and to stop the production process of shirts. In this situation, the advice of Mike Smith will be applicable. When a producer cannot bear its minimum average variable cost, then this company will reach at its shut-down point. Above this shut-down point, a company should continue its production process. However, at this point, the company should stop producing its output, as it cannot bear its average variable cost and average fixed cost. This can be explained by an appropriate diagram.

Fig 1: Shut-down point of a firm

Source: (created by author)

The shut-down point of a firm is shown in the above diagram (Vidaillet and Gamot 2015). Here, the minimum point of an average variable cost is shown in the above diagram. As the company is operating above its shut-down point, it will be good for this Meetoo Company to continue its production in the Singapore factory (Novák and Popesko 2014). However, this will have some negative impacts and negative risk assessment on this company.

In the long-run, a company will have only variable costs. Hence, it can gradually stop its production process. In a long-run, a company will have enough time to gradually close its factory. Hence, any factor of production will not be negatively affected to a large extent. Moreover, it will not affect this company negatively (Peters, Roberts, Vuong and Fryges 2017). The Meetoo Company can gradually reduce its labor force. Moreover, it will have enough time to sell its capital, like machineries, to other companies. Hence, the amount of both variable costs and fixed costs will be reduced over time. In this situation, the amount of negative risk assessment will be low, as well. Hence, the company will have enough time to close its factory without any negative impacts. In this situation, the decision of Mike Smart will be correct during the long-run.

b)There are some other factors, which should be analyzed before taking any decision to close a factory. This is because; a production process is not only based on any particular factor. As it is a long-term process and many factors are employed over here, it is very difficult to take a decision regarding the shut-down process of a factory. Hence, before taking any steps, some other factors should be analyzed. Except the cost structure of production, those factors have a great influence on this Meetoo Company. Therefore, the board members of this company will gather some other environmental, economical and political information of Singapore, before reaching to this decision. Under environmental factors environmental regulations, requirement of compliance and waste management will be discussed. Moreover, under the economical factor, low level of profit, high level of competition, problems regarding good management, production process, resource problem and raw materials will be discussed.

A) Cost Structure and Production Analysis:

Natural Environmental Factors:

Regulations regarding Environment:

The government of a country takes some regulations to protect the environment of that country. A company should meet certain standard at the time of production. This will help the company to decrease any adverse effects on environment, at the time of production. When a company creates excess amount of pollution, negative externality is created (He 2014). The government of this country can impose a tax or charge fine for this. As a result, the company will bear some extra costs, except fixed and variable costs. Moreover, use of harmful raw materials may create negative externalities. This negative externality creates excess cost burden for a company.

In the Meetoo Company’s factory of Singapore, this situation can be occurred. This factory may create excess amount of pollution. If the government of Singapore charges extra amount on this company for creating pollution, the company can shut its factory in the short-run. As this external cost will increase the total cost of the company, it will be better for Meetoo to close this factory in Singapore. For different countries, the government regulation will be different. Hence, the cost pattern will be different for these negative externalities. In Singapore, this may be high and for this reason, the company can close its factory.

Requirement of Compliance:

There are some natural environmental factors that affect a business to operate efficiently. Moreover, at every stage of production, the company should follow some regulations regarding environment. Companies with high level of noncompliance have risk to shut its company for a permanent basis. For the factory of Singapore, this noncompliance may be high and that will adversely affect the company.

Waste Management:

In a production process, some waste materials are generated. Those waste materials are harmful for an environment. Waste can be generated either in solid or liquid form. Moreover, some wastes can also be generated in the form of gas. For every form of waste, disposal process is different (Ma, Yin and Liu 2017). However, waste disposal is essential, as create environmental pollution. Hence, producing output with huge amount with hazardous raw materials is not good. It implies that the company is not operating its production process efficiently. The government may impose tax or charge fine if the company creates huge amount of waste. This will increase the total cost level of producer. Hence, it is essential for to Meetoo Company to manage its waste in Singapore. Otherwise, the government of Singapore may impose tax on this factory.

B) Other Factors to be Considered:

Economical Factors:

Economical conditions are the chief reason for shutting down a factory. If the country is facing higher level of inflation or deflation for a long time, then it will be harmful for any business activity (Rivoli 2014). On the other hand, low level of national income also effects a business organization, directly. In Singapore, the level of inflation was very high for last few years. This may be a reason to shut the factory.

Low level of profit:

The Meetoo Company has other factories except Singapore. In Singapore, it incurs loss by selling its shirt at a lower price than its production cost. It is important to find out the profit level of all other factories of this company. If the overall profit level of this company is low, then the producer will get lower level of income. In this situation, it will be better for this company to shut its Singapore factory in near future. However, at present, the company should continue its production process in this factory. It will reduce its extra burden of cost.

Hence, in short-run, the company cannot close its factory immediately. However, by selling its fixed factors and assets and by reducing its labor force, the company can close its factory in long-run.

High level of competition:

In today’s world, the level of competition for each company has increased significantly. Due to globalization, every business organization faces a strong competition in domestic market and in international market.

The Meetoo Company operates its business in a monopolistic competitive market. Hence, this company has large number of competitors, who produce shirts. In Singapore, this company may not competitive with other domestic and international companies. This may happen due to some factors (Balachander, Gal-Or, Geylani and Kim 2017). Citizens of Singapore may not have enough demand for those shirts of Meetoo. As the demand is low, it will be economically irrelevant to continue the production process in Singapore. Due to low level of demand, the company is selling its products by incurring loss. In Singapore, the market condition is very strong and competitive. Moreover, under this market condition, the company will have to bear advertisement cost. To promote their products and to increase the demand for their shirts, advertisement cost is essential. However, this advertisement cost increases the total cost amount of this company. Hence, the company will reduce its advertisement cost and as a result, the demand for shirts will be decreased.

Environmental Factors:

Management problem:

Management is an essential part of a company. It helps this company to operate its production process efficiently. Moreover, it also helps a company to take correct business decision. However, a weak management body may hamper the production process.

The Meetoo Company may not have a strong management body. Within a company, a strong managerial structure will help to earn extra profits. It also helps the company to increase the demand for its product. However, in this Meetoo Company, the management structure may not be strong. For this reason, the company is selling its product at a price, which is lower than its cost price (Lin, MacMinn, Tian and Yu, 2017). Due to this weak management structure, the company may close its factory in Singapore. Without considering any economical affect, the management can take the decision to shut this factory. However, a strong management body will continue its production process in short-run by considering all economic impacts.

Production Process:

Along with a good management system, a good production process is also required. By a good and efficient production process, a company can produce large number of outputs with lower cost. For this good production process, a well-developed technology and a good strategic plan are also required. However, due to geographical differences, this production process also differs. Hence, the board of Meetoo Company should consider this production process.

Resource problem:

To produce a product, a company needs four types of factors. These are land, capital, labor and organization. Each and every factor is very important. Moreover, a good technological innovation is also required. However, in Singapore, the cost of any one factor or all factors may be high (Kosacka and Werner-Lewandowska 2017). That will increase the total production cost of shirts. However, the company cannot sell its product at a higher price due to high level of competition.  Hence, it will be fruitful for this company to shut its factory in Singapore.

Raw Materials:

To produce a shirt, the chief raw material is fabric. This fabric is made from natural fibers. These natural fibers are linen, wool and cotton and so on. The availability of this raw material is very important (van der Velden, Patel and Vogtländer 2014). Moreover, the price of raw material is also important. Hence, the head of Meetoo Company should observe this availability. If raw material is not easily available and price of fabric is high, then further production will be stopped.

Economic Factors:

Political factor:

The political condition of a county also has a great influence on the production process of a company. If political condition is not stable, then this may adversely affect this company (Kotabe, Jiang and Murray 2017). Political disturbance cannot help a company to develop its business. Hence, to close a factory in Singapore, the political condition of this country should be considered.

However, in Singapore, the political condition is stable. This island is helpful for every business organization to grow their business. Hence, in this context, this political factor will not be affective. However, any political disturbance in near future will hamper the production process of Meetoo Company.

Hence, from this above analysis a conclusion can be drawn. It can be said that there are various factors, which are also very important for a business organisation. These factors have a great influence on a company to take decision. These important factors are chiefly based on environmental, economical and political conditions of a country. Other than cost structure, those factors influence a company to take business decision (Leonidou, Christodoulides, Kyrgidou and Palihawadana 2017). Therefore, before taking any decision, the Meetoo Company will consider those factors. After analyzing those affects, the company will either close its factory or will continue its production.

c)Risk assessment determines both quantitative and qualitative risks of a company, related to a particular situation. Quantitative risk assessment needs two components to measure its risks factors (Song, Chan and Wright 2017). These two components are the probability of loss that will occur and the potential loss. As the Meetoo Company may shut its factory in Singapore, it will have some negative risk assessment. Hence, the company should prepare a risk assessment program before closing their factory in Singapore. These risks will be raised from its labor force, capital investment, and profit level of the company.

In Singapore, the company has hired many skilled and unskilled labors to produce shirts. When they will close their factory, those labors will be unemployed. As Meetoo is a U.S based company, it will have its other factories in U.S or in other countries. But in Singapore, it has only one factory. Hence, those workers do not have any other option to move. They will be jobless. Hence, the company should give them a fixed amount of money.

The company also has hired other factors of production except labor force. These are land and capital. Those two factors will also be unemployed when the company will close its factory. The company will bear a certain risk for this.

Political Factors:

Moreover, there are some other external factors, which can adversely affect this company for taking any decision. High level of competition of other firms, risks and uncertainty are included in this external risk assessment of this company.

Hence, the Meetoo Company will prepare a risk assessment program to overcome this. At first, they will identify those risks, which will occur after closing the factory. Secondly, the company will quantify those risks according to their effects on business. Thirdly, the company will form proper strategies to control those risks. Fourthly, the Meetoo Company will implement those strategies for reducing risk. Lastly, after implementing those strategies, the company will observe those risks factors continuously. The company will do this to see that whether those risk assessment factors will further affect the company or not. Hence, a proper risk assessment program should be arranged. This risk assessment program is shown in the table below.

Risk that need to be analyzed:

The company should classify its risk assessment properly before taking any decision. By evaluating its risk factor, the factory can perform efficiently and strongly in near future

Reference:

He, G., Zhang, L., Mol, A.P., Wang, T. and Lu, Y., 2014. Why small and medium chemical companies continue to pose severe environmental risks in rural China. Environmental Pollution, 185, pp.158-167.

Kosacka, M. and Werner-Lewandowska, K., 2017. Methodology for Sustainable Resource Management Measurement at a Company Level-Case Study. Procedia Manufacturing, 11, pp.725-733.

Kotabe, M., Jiang, C.X. and Murray, J.Y., 2017. Examining the complementary effect of political networking capability with absorptive capacity on the innovative performance of emerging-market firms. Journal of Management, 43(4), pp.1131-1156.

Leonidou, L.C., Christodoulides, P., Kyrgidou, L.P. and Palihawadana, D., 2017. Internal drivers and performance consequences of small firm green business strategy: the moderating role of external forces. Journal of Business Ethics, 140(3), pp.585-606.

Lin, Y., MacMinn, R.D., Tian, R. and Yu, J., 2017. Pension risk management in the enterprise risk management framework. Journal of Risk and Insurance, 84(S1), pp.345-365.

Ma, Y., Yin, Y. and Liu, Y., 2017. A holistic approach for food waste management towards zero-solid disposal and energy/resource recovery. Bioresource technology, 228, pp.56-61.

Novák, P. and Popesko, B., 2014. Cost variability and cost behaviour in manufacturing enterprises. Economics & Sociology, 7(4), p.89.

Peters, B., Roberts, M.J., Vuong, V.A. and Fryges, H., 2017. Estimating dynamic R&D choice: an analysis of costs and long?run benefits. The RAND Journal of Economics, 48(2), pp.409-437.

Porter, M.E. and Heppelmann, J.E., 2014. How smart, connected products are transforming competition. Harvard Business Review, 92(11), pp.64-88.

Rivoli, P., 2014. The travels of a t-shirt in the global economy: An economist examines the markets, power, and politics of world trade. New preface and epilogue with updates on economic issues and main characters. John Wiley & Sons.

Salas-Molina, F., Martin, F.J., Rodríguez-Aguilar, J.A., Serrà, J. and Arcos, J.L., 2017. Empowering cash managers to achieve cost savings by improving predictive accuracy. International Journal of Forecasting, 33(2), pp.403-415.

Song, Q., Chan, S.H. and Wright, A.M., 2017. The Efficacy of a Decision Support System in Enhancing Risk Assessment Performance. Decision Sciences, 48(2), pp.307-335.

Trantopoulos, K., von Krogh, G., Wallin, M.W. and Woerter, M., 2017. External Knowledge and Information Technology: Implications for Process Innovation Performance. MIS Quarterly, 41(1), pp.287-300.

van der Velden, N.M., Patel, M.K. and Vogtländer, J.G., 2014. LCA benchmarking study on textiles made of cotton, polyester, nylon, acryl, or elastane. The International Journal of Life Cycle Assessment, 19(2), pp.331-356.

Vidaillet, B. and Gamot, G., 2015. Working and resisting when one’s workplace is under threat of being shut down: A Lacanian perspective. Organization Studies, 36(8), pp.987-1011

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