Low-Calorie Frozen Food Industry Research Paper Examples

Assignment 2: Operations decisions

The price elasticity of demand calculated in assignment 1 indicates that the industry for flow-calorie frozen food is a competitive market. The price elasticity was more than 1 showing that a change in price of the food causes a significant change in quantity demanded. The value implies that firms in the market do not have much power to the prices for their commodities. The competitors of the firm include Nestle SA, Kellogg Company, Birds Eye Foods, among other companies. The high price elasticity enables businesses in the market to use pricing strategies in order to attract and maintain customers. Birds Eye, for instance, offers discounts to retailers, who are the company’s primary customers. Nestle has also adopted a policy of charging lower price while trying to maintain the quality of its products.

Effectiveness of the market for the company’s operations

This section uses the demand, and supply equations given in assignment 1 as well as the cost functions determine whether the firm’s operations are profitable in this competitive market. A market can only be suitable for the operations of a business if such operations are profitable thus enabling the firm to recover all its production costs and guarantee a profit margin.
The demand equation is, Q = 38,650 – 42P implying that price per unit is given by: P = 920.24 – 0.0238Q. Using this function, the total revenue for the firm can be obtained as follows;
Total revenue = [920.24 – 0.02381Q] × Q = 920.24Q – 0.0238Q2. The margin revenue for the firm’s product is, therefore, given by the equation: 920.24 – 0.0476Q. In this market, the firm produces and sells the quantity that equates its marginal cost and marginal revenue. The profit-maximizing quantity for the firm is as follows:
100 + 0.0126424Q = 920.24 – 0.0476Q
The profit-maximizing quantity is 13,616 units and the corresponding price is 596.18 cents.
Total revenue for 13,616 units = 13,616 × 596.18 = 8,117,586.90
Total cost for 13,616 units = 160,000,000 + (100 × 13,616) + (0.0063212 × 13,6162)
= 162,533,521.80
As shown above, the total revenue will be far less than the total cost of the firm if it produces and charges the above quantity and price respectively. The company makes a total loss of 154,415,934.90. This shows the market does not favor the operations of the business as they lead to losses. The company’s variable cost is 2,533,521.80 hence it has a positive contribution margin. The competitive market does not favor its operations since the quantity is not adequate to generate sufficient contribution to cover the high fixed cost. In addition, the price does not generate sufficient revenue to cover the firm’s total costs. The company cannot change this price since it sells in a competitive market.

Change in market structure to imperfect competition

The change in the market structure from perfect competition to imperfect competition is likely to help the firm in its quest to enhance its profitability. The change may have resulted from intense competition and increased focus on non-price competitive measures. The market was initial so competitive making it difficult for smaller firms to survive (Samuelson & Nordhaus, 2010). This has seen several companies withdrawing from the market. The remaining firms experience an increase in their market powers thereby lowering the price elasticity of demand. This gives the existing firms additional powers to set their prices thus leading to imperfect competition. In addition, smaller firms that cannot survive competition may have been acquired by larger companies. The market has seen several mergers and acquisitions. Horizontal acquisitions lead to larger firms with large market firms thus enabling them to influence the pricing of their commodities.
The increased in non-price competitive measures by the existing firms may have also caused the change. Frozen food companies have been under public scrutiny in the past years due to issues of health as the number of obese people in USA continues to rise. Many consumers favored them due to their low cost. However, things have changed as most consumers pay more attention to their health than to the prices. In addition, firms have engaged in non-price competition strategies such improving quality, packaging, advertising, among other factors. Some companies have also entered into long-term contracts with customers such as stores. These factors have reduced the influence of price to purchasing decisions as some customers have developed preference for particular brands.

Cost functions and their importance to decisions

The short-run cost function of the firm consists of variable costs such as the cost of ingredients, direct labor costs, among other expenses. In this case, the short-run cost function is given by 100Q + 0.0063212Q2, which is the firm’s variable cost. The fixed cost is excluded from the short-run cost functions since it does not or is not affected by any short-run price and output decisions. In the short-run, the firm will incur the same amount of fixed irrespective of the level of production or any other short-run decisions. The short-run cost functions are applied in making managerial decisions regarding prices and output in the short-run. In the case of pricing decisions, a firm must ensure that its short-run price is more than the variable cost. A company with a positive contribution margin should not discontinue its operations regardless of the amount of fixed costs. Output decisions also ignore fixed cost in the short-run since such decisions use marginal analysis.
The long-run cost function for the firm includes variable costs such as cost of food ingredients, among others, and fixed costs such as depreciation, plant maintenance costs, among other fixed costs. The long-run cost function for this firm is, therefore, given by: 160,000,000 + 100Q + 0.0063212Q2. The function is applied to long-run managerial decisions. For instance, in making pricing decisions, the price set should be able to cover both the average variable cost and the average fixed cost (Silberberg & Ellis, 2010). Long-run output decisions must also consider the cost as they may involve changes in plant’s capacity thereby affecting fixed costs.

When should the firm discontinue its operations?

The decision to suspend or not depends on the position of the firm’s revenues relative to its costs and whether it is in the long-run or short-run. The firm should shut down if its average revenue is less than its average variable cost in the short-run (Tucker, 2010). Fixed costs are incurred in the short-run whether operations are continued or not. Therefore, if the firm has a positive contribution, discontinuing operations will lead to more losses. If the contribution margin is negative, the company should suspend its operations even in the short-run (Tucker, 2010). This may occur if the market is so competitive making it difficult for the firm to charge higher prices as doing so will lead to fall in sales. It may also be caused by the inability of the firm to control its variable costs. When variable costs are consistently rising, the company is likely to have a negative contribution margin. The management can salvage this situation by enhancing efficiency through training and using appropriate production technologies. In addition, the firm can reduce input costs by entering into long-term contracts with suppliers.
In the long-run, the firm should discontinue operations if its average total cost outweighs the average revenue. In this case, the price must cover both variable and fixed costs. The firm can discontinue if it is not able to control its fixed costs by enhancing efficiency in its operations (Jehle & Reny, 2010). Fixed cost can be reduced by improving efficiency through measures such as training, proper supervision, closing non-value added branches, among other measures. Another long-term solution is the acquisition of smaller competing firms.

Pricing policy and profitability

Analysis has indicated that the profit will not be the same for the perfect competition and imperfect competition markets. In the new market structure, the firm should produce where marginal cost and marginal revenue are equal and charge the corresponding price as shown below.
Total revenue = Total quantity produced and sold × price per unit
P = 920.24 – 0.0233Q (from the demand equation in assignment 1)
= [920.24 – 0.0238Q] × Q
= 920.24Q – 0.0238Q2
Marginal revenue = 920.24 – 0.0476Q
Marginal cost = 100 + 0.0126424Q
100 + 0.0126424Q = 920.24 – 0.0476Q
Q = 13,616 units
P = 920.24 – (0.02381×13,616) = 596.18 cents
Total revenue for 13,616 units = 13,616 × 596.18 = 8,117,586.90
Total cost for 13,616 units = 160,000,000 + (100 × 13,616) + (0.0063212 × 13,6162)
= 162,533,521.80
Total profit = 8,117,586.90 – 162,533,521.80 = -154,415,934.90

Assuming the firm is operating at equilibrium values:

Total revenue = 384.5 *22,501 = 8,651,634.50
Total cost = 160,000,000 + (100*22,501) + (0.0063212 × 22,5012) = 165,450,492
Total profit = 165,450,492 – 8,651,634.50 = 156,798,857.50
The best pricing strategy is to charge 596.18 cents and produce 13,616 units. These are the values that equate marginal cost to marginal revenue. The company will make a loss of 154,415,934.90. The above calculations indicate that the loss is contributed to by the firm’s high fixed. This may be due to the low level of efficiency. The fixed cost is more than 98% of the total cost.
Supposing the firm charges the equilibrium and produces the at the equilibrium quantity, the loss will increase to 156,798,857.50. This shows that the best price is 596.18 cents. The results further illustrate that the new market structure gives the firm additional powers. It can increase its price from the equilibrium price to 596.18. However, the quantity sold is reduced although the proportionate reduction is less than the proportional change in price.
Many firms have been entering the low-calorie foods market in recent years. This is expected to continue since the market is still growing. Additional regulations may also be imposed on the firms to enhance healthy foods and reduce the cases of obesity. The increase in cost of agriculture will also see an increase in the cost of inputs. These factors will raise competition.

Measures to improve performance

The company’s main problem is high fixed costs. It can, therefore, it can improve performance by training employees, using proper production methods, experienced workers and closing down loss-making operations (Besanko & Braeutigam, 2011). These measures will improve efficiency thus cutting fixed costs. It can also acquire or form mergers with other small firms. This will enable it to reduce operating costs through economies of scale as well reducing competition in the market. It can also source raw materials from suppliers having cost advantages in order to reduce variable cost. Variable cost may also be reduced through vertical integration.

References

Besanko, D., & Braeutigam, R. (2011). Microeconomics. Hoboken, N.J.: Wiley.
Jehle, G., & Reny, P. (2010). Advanced microeconomic theory. Harlow: Financial Times Prentice Hall.
Samuelson, P., & Nordhaus, W. (2010). Economics. Boston: McGraw-Hill Irwin.
Silberberg, E., & Ellis, G. (2010). Principles of microeconomics. Boston, MA: Pearson Learning Solutions.
Tucker, I. (2010). Microeconomics for today. Mason, OH: South-Western Cengage Learning.