What determines the steepness of the SRATC curve

We have two main points which determines the steepness of the SRATC curve. The most obvious one is the costs associated to your business activities, and by extraction of that, the business type itself, regarding the goods and services you provide and the market where you exert.

The average total cost is the aggregate of all fixed costs you have in a firm essentially based on:

-. Amenities/ machinery,

-. Raw materials needed,

-. Capital,

-. Labour for the salary on your regular employees,

And the variable cost represents the next cost needed to produce more if you have reached the maximum of the production capacity, Q*<Q.

At Q<Q*, the main impact is the fixed costs, and higher it is, more the activities is vulnerable and steeper the curve is, especially at low level of outputs. The time needed to reach Q* output is determinant (linked to the demand )

For example, if you are the CEO of an enterprise of ship-owner , the investment to start your activities will be huge (at minimum a boat, an anchor point and crew team) and you haven’t left the port. If you haven’t any demand, your fixed costs still present.

Type 1 of vulnerability is composed of :

-.fixed cost

“The Bigger this is, the more power full is the impact of falling average fixed costs on average total costs, so the short run ATC will be steeper, making business more vulnerable to external shocks.” Warwick MBA for IBM Lesson 1 (Ben Knight, 2011)

-.”quasi fixed” cost,

On high level of knowledge for employees, difficult to replace, or investment made not already

-.”IRL effect” appears at low level of variable cost and output of a production.

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Do you think vulnerability is the same if Q > Q*? If not, why not?

As the Fixed costs decrease during the increasing of output, we will examine the variable costs.

At Q*, you should be at the main efficient point where outputs are at the maximum without additional cost (fixed and variable) to maximize your profits also called Production Possibility Frontier (PPF) if we produce only one product.

Above Q*, there will be an increase of costs (you have to spend more to allow extra output) and an increase of Marginal Cost, so additional cost. We are in Diminishing Returns Labour (DRL). Each additional output cost more than previously

For a factory, If you decided for example to produce during the night, you will have to increase the workforce. But as we are in DRL, the extra output will cost more that the previous one.

As said, the fixed cost for the Ship-owner makes this different, as to produced more, he has to bought another ship.

We are facing Type 2 of vulnerability, du to the change of inputs costs as “bought IN” cost (labour, Raw Materials ) in regards of extra output (increasing).

What do you think the SRATC curve looks like for the following companies? (Draw these and explain your drawing.)

Accor Hotels

“Accor SA is a France-Based Company providing a range of Services around two core business segments, such as hotels and Services. The Hotel Division manages approximately 500,000 bedrooms in more than 4000 hotel across 90 countries. Its hotel operated under a series of brands names notably Sofitel, Pullman Mercure Suite hotel….”

http://data.finlistics-vm.com/BVCreateReports.asp IBM CBV report [accessed : 11 april 2011)

As Fixed cost decreasing when output increase, we have high cost if rooms are underutilized. The SRATC curve is stopped by the volume of room than Hotels have. At Q*, all the rooms are used. Variable cost are insignificant and are ‘quasi fixed’ costs (Labour, laundry etc…). It makes Accor highly vulnerable to external Shocks.

The economics recession, (decreasing income) added to high elasticity in demand, put the Accor company struggling the situations more harder than other business with a high debt du to previous investment. Ben Knight (2010) explains : “Financial Vulnerability, especially for business with high level of debt is important, especially in a global recession”.

Since 2006, They sold non core activities to focus on Hotel activities. The paroxysm of theses actions was on June 2010, where Accor sold the services branch. The Answer from the market was as follow :

Google Finance, 2011. ACCORD SA Stock. [Online] URL: http://www.google.com/finance?q=EPA%3AAC (Accessed April 2011)

In parallel, the Accor strategy is to reduce by variabilization the fixed cost. It has started in 2007, where Accor has started to make agreements with other company to buy/sell/exploit hotels regarding the added value and the market.

They keep, in mature countries, the luxury part (where demand is inelastic) and share the risks on middle and low segments for all the markets, specially on emerging markets (where demand is elasticitic ):

Accor. Registration Document and Annual Financial Report 2010 [online]http://www.accor.com/fileadmin/user_upload/Contenus_Accor/Finance/Documentation/2011/EN/2010_registration_document. [Online] [Accessed may 2010, p146]

AC Milan (a football club)

For AC Milan, it’s quiet different.

The Fixed cost is composed of huge salaries earned by players. This is known at least for the current year (except rewards, du to the experience of the club it’s assumed that is a fix quota). So the fixed costs are a line which allows the team to play national competition at Q level. The main idea then, is for the club to be among the best of the team across Europe, to participate to champions league’s to maximize the profit (by playing more match and to increase revenue for rights on tv and spectator in the stadium, merchandising etc…).

John Old’s landscape gardener which has an owner manager plus 1 permanent employee

Du to the fact that’s a Job to job based activities, all output are planned, and often you have some delay between the first quotation and the beginning of the task/work itself. The main exposure is when there is no more backlog.

So the SRATC is like a “Saucer” in this case. There is low type 1 vulnerability as in mature countries, theses activities aren’t attractive and there is a lack of artisan. It could make an opportunity to maximize the profits by increasing the price, with the same Costs regarding output level when there is an increase of income.

IBM

a)IBM is composed of several Business Unit where the costs and output are very different. Mainly we can differentiate Hardware, Software and Services.

I will take the Hardware Brand.

The Hardware brand developed new hardware to improve capacities ( calculus, Thermal release, energy) in relation with increasing needs from customer. The budget for the research and development are quite strong in this area year after year, as the innovation on a purely hardware aspect make the difference versus competitors and needs high skills. The variable costs are mainly linked to the supply chain activities where above the Q* level, there is an increase of variable costs (in labour, raw materials).

While the global recession, the budget allowed for IT was falling. Hardware have seen its revenue decreasing. Even if the cycle of amortization was finished, it was not a priority for company to renew the hardware, only obsolete and end of support hardware were.

The elasticity of demand hardware is medium because even companies were in the same situation, for some business activities it’s vital (e.g banking and financial sector).

In addition, the sales are mostly made through business partner channel which represents a back-end variabilization.

So SRATC curve is between the ‘Flute’ and the ‘saucer’ one. The sales are mostly made through business partner channel.

Assess the type 1 and type 2 vulnerability of each of these businesses:

Briefly outline a strategy for reducing business vulnerability and assess the importance of ‘variabilization’* in reducing type 1 and type 2 vulnerability.

As the world is faster, integrated, the costs expose your business to fluctuation and events at microeconomics and macroeconomics level. As we have seen, to be pertinent in a business you have to handle the situation and to manage what is at your hand, the fixed costs. The variabilization helps to decide what are the exposure you will be ready to cope, between Type 1 and Type 2 vulnerabilities,even if you have to decide the right level for the balance between this two…. The main purpose is to transform the SRATC curve to a ‘S’ curve where you decide what are

Nicolas Kachaner (2009) explains :”Organizations that variabilize their costs cas master the business cycle rather than be whipped by it”.

From this point few way appear to reduce vulnerabilities:

Briefly consider the impact on IBM of a) the global recession of 2008/9 and b) increases in the price of energy in 2010/11.

a) IBM has three main Business activities which are different in terms of investments, volume (i.e. revenue and cost), in the gross profit margin and in time ( e.g. Software licence vs outsourcing). Mainly we can differentiate Hardware, Software and Services (i.e. There is two kind of services, if we are in run or build phases)

In complement IBM is a global integrated company, with a presence Worlwide and global delivery through the world.

As we have seen for hardware, the SRATC is between ‘f’ and ‘s’ curve. Du to the existing park, the SRATC curve for Hardware is less steeper than SRATC Service Build du to the obsolescence of hardware as explained previously.

Curves for Software and Services run are quietly equivalent, for different reasons. Software brand developped software and once the products are available, there is no more cost asociated (fixed and variable), as the sales channel is based on business partner.

For the SRATC Run services, there is two main activities which are the outsourcing and the maintenance.

In short run, it’s obvious that customers have already made the variabilization of their fixed cost, in outsourcing their IT production. It’s often long term contract during severals years. All the IBM’s inputs are mutualized. At each new contract, fixed cost are decreasing more quicker than variable costs.

For the Maintenance, It’s the same. You know your potential revenue and cost on a year basis at least. The inputs ressources are mutualised too.

The SRATC for Build service were impact strongly but with some delay, du to the strong backlog, and the effect of recession was only seen at the end of 2009.

During this period, few decisions were taken to reduce cost at the minimum. There were constraints on fixed cost like vehicles (modification of categories), buildings (We are no more owner of the buildings) and on variable costs with Cloud Computing strategy to preserve gross profit the decreasing of cost.

It was also for Maintenance Services to increase its revenue as there is a decrease of Hardware demand (end of Warranty period).

It was also an opportunity to support the SWG strategy in acquisition of others Software companies, has the value of society ware depreciated during global.

Finally, the mixed of different type of activities added to the different markets addressed (i.e. Emerging market where IBM invests massively versus Mature market where there is less investment), have helped IBM in coping the global recession.

IBM. Annual Reports 2010. [online].

Available at : ftp://public.dhe.ibm.com/annualreport/2010/2010_ibm_annual.pdf. [accessed : 11 april 2011]

b)The increase of price energy will have obvisouly an impact and it’s in the center of IBM strategy, further the first Green IT strategy (i.e. which aimed to reduce drastically the energy consumed) IBM developed the cloud computing.

“The cloud equation adds in the flexibility to scale bandwidth up or down at will and the affordability of pay-as-you-go service, and subtracts energy-devouring hardware from your local environment. Factor in the IBM security and experience that go into each of its industry-leading global cloud computing centers and myriad enterprise private clouds. The result: an instrumented, interconnected, intelligent approach to smarter computing.”

http://www.ibm.com/smarterplanet/us/en/cloud_computing/ideas/index.html