Strategies for maximizing business profits

Economics

Automation, Fixed Costs and Variable Costs

Organizations, especially manufacturing organizations, may often have a choice concerning the way they operate, either utilizing a high level of automation, which is likely to require a significant capital investment, or utilize a high level of human labor, where the same level of investment in automation is not required, but costs associated with wages are likely to be higher. There are many influences on the way in which the level of automation, which has high fixed costs, and the level of labor which is a variable cost, will be determined.

To decide the most appropriate approach firms will consider the total cost of production. The total cost of production is made up of both fixed costs and variable costs. Fixed costs are those costs which remain the same, regardless of the level of production, such as the investment and management automation, where as variable costs are the direct costs which vary in line with the level of production, and include items such as materials and labor (Chadwick, 2007). To determine the most appropriate balance between automation and labor the budget will be used in order to calculate the average total cost per unit. For organizations that are seeking to maximize their profit the decision on whether to invest in the automation will be based on whether the equation of the total fixed costs plus the total variable costs divided by the number of units produced is lower if there is an investment in automation. It is because wages are lower in developing counties that many firms have invested in off shoring where the cost of labor is low; lowering the overall cost (Baye, 2007).

The use of high levels of automation may be beneficial where there is otherwise a high level of labor needed, it is particularly useful if the labor needed may be costly to provide; such as skilled labor or the need for labor to work is specific conditions. Industries may include semi-conductor factories, electronics, car manufacturing and even sectors such as shrimp fishing and food production. As automation requires a high level of investment, it is also most suited to industries where the firm expects to make a large amount of sales. High fixed costs increased the break even point and may reduce flexibility in a change market. So markets where there is a need for flexibility or there is uncertainty may favor greater human labor inputs.

Question 2

An example of a firm that has high fixed costs and low variable costs is an airline. The service offered relies on high level of capital investments in aircraft, as well as the support services. The variable cost per passenger is relativity low. The airlines will seek to minimize their variable costs as the same time as using the capital investments in a wise manner to maximize revenues. One example of this is Southwest Airlines, the founder of the low cost carrier model, where the variable costs are minimized with a no frills service.

The challenge faced by airlines is the sell sufficient seats on each aircraft to ensure that they break even or make a profit; this is due to the high fixed cost. One approach that been the used is dynamic pricing in order to manage the demand for the flights. If a particular flight is selling well and appears to be in demand, the price of the seats will remain high as the airline will increase revenue and will be confident that the seats will sell (Nellis and Parker, 2006) if seats for a flight do not appear to be selling well, the airline may reduce the price in order to stimulate demand to increase the number of passengers paying that will use that flight (Nellis and Parker, 2006).