Our company is current being faced with an increase in demand, and this has management considering our options with respect to filling this demand. One of the questions that has arisen is whether we should hire temporary workers or new permanent workers in order to meet this increased demand. This paper will explain using economic terms why we should hire temporary workers to meet this increase in demand.
The firm is currently experiencing an increase in demand for our main product. As a result, we are having difficulty meeting this demand with our current production levels. Our inventories are declining rapidly, and this is why we are faced with this decision. In order to make the right decision, we need to make an assessment of the nature of this demand. In simple terms, demand comes in two forms -- a permanent increase in demand or a temporary increase in demand.
In order to make this determination, we need to have an understanding of where this demand comes from. There are two possible explanations. The first is that the demand increase is the result of purchases for the holiday season. Many companies see an increase in demand at this time of year, as this is a peak shopping season for consumers. This is what is referred to as seasonal or cyclical demand. If this demand is cyclical, then we can expect that once the season begins to wane, so will the demand. The implication of this is that if we increase production now, we will be faced with higher production levels and higher inventory levels when demand falls in January. For the company, any increase in production would be detrimental. Hiring permanent workers in this situation would be even more detrimental, because it is more difficult to release those workers.
The demand increase may, however, derive from the improvements we made to the produce when we launched the latest version six months ago. In this situation, our response to the added demand depends on the type of industry in which we operate. If the industry is in a state of monopolistic competition -- that is to say if there are numerous competitors -- we can expect that one or more of them will match our innovations. There are few barriers to entry in such industries, and as a result somebody will catch up to us, and this will reduce our demand in the long-run. In the short-run, we are probably going to continue with higher demand but eventually we will lose our competitive advantage. If we are operating in an oligopoly with only one or two major competitors, and those competitors do not have our technological abilities, then the competitive advantage we have gained from this innovation will last us longer. Alternately, if our oligopolistic competitors are able to match our innovations, our market share will not change in the long run. In such a situation, our response is to engage in tacit collusion to maintain demand levels at a point that is mutually beneficial for each firm (Knittel, Lepore, 2006).
We may even be able to permanently extend our advantage, which would allow us to build our market share. Conversely, if our competition can match our innovation, our demand increase will be temporary in nature, lasting only until they catch up (Goettler & Gordon, 2008). The industry we are in is in a state of monopolistic competition, so we can expect that one or more competitors will match our innovations eventually, and our competitive advantage will diminish as a result. This will bring our demand back to the equilibrium point, because with the current industry structure profits are only reasonable in the short-run. We need to continually innovate in order to be continually profitable.
Permanent vs. Temporary Workers
The workforce at our facility is unionized. This means that there are significant costs associated with reducing our workforce. Once somebody is hired, it costs thousands of dollars to let them go. This creates a situation where the company is in conflict. We need to increase production, but we need to ensure that the demand increase in permanent before we hire permanent workers. The use of temporary workers allows us to increase our production in the short run. This way, if the demand increase is itself temporary, the workers will be too. When the time comes that we need to reduce the size of our workforce, we will be able to do so at a lower cost than if we hire the new workers on a permanent basis.
The economic costs to the firm associated with layoffs are more than simply the dollar value of eliminating surplus labor. There are other costs as well: costs to morale, the loss of talent, rehiring costs if business improves, and the costs to the stock associated with the perceived failure that resulted in the layoffs (Colvin, 2009). All of these costs are more associated with permanent workers than with temporary ones. When temporary workers are let go, this is something that all stakeholders expected from the outset of the arrangement. The layoffs have minimal effect on morale, Wall Street expected it, and the pool of workers removed probably had few potential leaders (any that were there could be retained). In addition, the company loses fewer sunk costs with temporary workers. Because of the temporary nature of the work arrangement, less is invested in the hiring and training process. There are no costs associated with indoctrinating these workers into the corporate culture. In other words, temporary workers cost less up front, and the cost of removing them from the labor pool is lower as well. Permanent workers, on the other hand, are subject to expensive recruitment and selection processes, training and acculturation processes, and with our union the cost of releasing even new workers is quite high.
We have evaluated the demand function and we believe that although we are currently enjoying success, the type of industry in which we operate is both likely to have seasonal demand and is likely to see competitors make improvements to their products. As a result, we do not see the current upward trend in demand as being permanent in nature. More likely, when our competitive advantage dissipates and the seasons change, demand for our product will return to equilibrium. We do not see that aggregate industry demand has improved -- we are simply in a position of disequilibrium that was caused by the technological innovations in the latest iteration of our product.
Since the demand increase is not expected to be permanent, we should only hire temporary labor to increase capacity. If we hire permanent labor, we will increase our cost structure permanently. The result of this is that when for our product decreases, our profits will too. We will either lose sales to competitors, or we will need to reduce prices in order to maintain the same level of demand. In either case, our revenue will decline. With a higher cost structure, so too will our profits. Temporary workers give us the flexibility to adapt our cost structure to the prevailing revenue levels. The greater the portion of our labor that is considered a variable cost, the more we will be able to manage our costs. We want to maintain certain margins for our company overall, and this means tying the variable labor costs to the revenues. Only temporary labor allows us to do that.
If, at a later date, it becomes apparent that the increase in demand we are currently experiencing is permanent in nature, we can convert our temporary workers to permanent ones. It is easier to move in that direction, than to release permanent workers and re-hire them as temporary. When considering the firm's cost structure, it is…