Firms Recovery Process and Profit Maximization Strategies - Essay Example

This is a report analyzing a firm’s production and providing recommendations on how to improve its performance. The report explores various recovery processes and profit maximization strategies that can be used to turn around this firm that is on the verge of collapsing into a profitable venture. Using various economic variables, this report seeks to determine the extent of a firm’s losses or profits and devise strategies to improve the production unit’s economic performance. The report employs various accounting and econometric methods to ascertain the firm’s economic viability. Previous literature on the same subject has been used to help in formulating the strategies.

Keywords: production unit, profit maximization, business strategies.

Dutta and Radner (1999) argue that profit maximization should be the basic guide in any business strategy. They define profit as the excess of total revenues over cost and loss as the excess of the total cost on total revenue. Kreps (1990) defines total revenue as the product of price and quantity produced, and total cost as the sum of variable cost and fixed cost. 

Total revenue = $25*200,000 = $5,000,000

Total labor cost = wage per worker * number of workers

Total labor cost = $80 * 50,000 = $4,000,000

Total variable cost = total labor cost + other variable cost

Total variable cost = $4,000,000 + $400,000 = $4,400,000

Total cost = total variable cost + total fixed cost

Total cost = $4,400,000 + $1,000,000 = $5,400,000

Since the firm’s total cost of $5,400,000 exceeds the total revenue of $5,000,000, it is operating on a loss of $400,000.

Kreps (1990) points out that in a competitive market if the price is greater than the average variable cost, the firm should continue producing and if the price is less than the average variable cost then the firm should shutdown at the point where the price is equal to average variable cost. He argues that Shutting down will save the firm from incurring more losses as any additional production leads to more additional costs greater than the price. The firm’s selling price is $25

Average variable cost = total variable cost / quantity produced.

Average variable cost = $4,400,000 / 200,000 = $22

The analysis above shows that the price is greater than the average variable cost and therefore this report recommends that the firm should continue producing.

This report recommends that this firm should reduce its losses by reducing the labor cost without reducing productivity so that it can “breakeven”. According to Dutta and Radner (1999), the breakeven point is the level of the point of production where total revenue is equal to the total cost. This means that the firm is able to meet its expenses but is making a zero-dollar profit.

 Current labor productivity = units of output per day/number of workers.

Current labor productivity= 200,000 / 50,000 = 4

Optimal number of workers that can be laid off = loss / daily wage.

= $400,000 / $80 = 5000 people.

 New labor productivity = 45,000 / $80 = 4.4

 The 10 percent increase in labor productivity can be attributed to the optimal utilization of the available capital.

The other option for this firm is to increase sales up to the point where quantity produced maximizes profits. Brume and Easley (2008) conclude that healthy competition is beneficial to the market. They argue that in a competitive market, only the economically viable firms survive reducing redundancy in the market.  If this firm is operating in a competitive market, it cannot set its own price and therefore can only maximize its profits by producing at the point where marginal revenue is equal to marginal cost Kreps (1990). Kreps points out that a firm operating in a monopolistic market, can set its own price and will maximize its profits at the point where the price is equal to the marginal cost but can still sell at a price above its marginal cost curve. Dutta and Radner (199) argue that a change in price in an oligopolistic market structure will lead to an equivalent change by other firms in the same direction above the kinked demand curve.

To increase sales, the firm has to vigorously advertise its products through the available medium of advertisements. It also has to improve its customer relations by providing after-sales services and adopting modern customer care services techniques. The firm should also increase the quality of its products to create customer loyalty.