Chapter 11: Notes

Information and the Decision Process

Managers usually use a decision model (formal method of making choices involving both qualitative and quantitative analyses) for choosing among different courses of action. Ex of a strategic decision: should a sporting goods store reorganize its manufacturing operations to reduce manufacturing labor costs? (the two options it has is to organize or stay the same) Five step decision model: 1. Identify the problem and uncertainties: Should precision sporting goods reorganize its manufacturing operations to reduce manufactiing labor costs? An important uncertainty is how the reorganization will affect employee morale. 2. Obtain information: historical hourly wage rates are $14/hour. However, a recently negotiated increase in employee benefits will increase it to 16/hour. The reorganization is expected to reduce the number of workers from 20 to 15 by eliminated 5 material handlers, most likely this will have a negative effect on employee morale. 3. Make predictions about the future: under existing do-not-reorganize alternatives, costs are predicted to be $640,000 and under the new reorganized way costs will be 480,000. The organization costs will be 90,000. 4. Make decisions by choosing among alternatives: after comparing the costs it still makes sense to go the reorganize route (saves 70,000) because of the financial benefits and the effects on employee morale are expected to be temporary and relatively small. 5. Implement the decision, evaluate performance, and learn: evaluating performance after the decision is implemented provides critical feedback for managers, and the five step sequence is tehn repeated in the whole or in part. Managers learn that the new manufacturing costs are 540k rather than 480k. because of lower-than-expected manufacturing labor productivity. This (now) historical information can help managers make better subsequent predictions that allow for more learning time. Alternatively, managers improve implementation via employee training and better supervision.

The Concept of Relevance

Relevancy ties directly with step 4 (making decisions by choosing among alternatives). Relevant Costs and Relevant Revenues Relevant costs are expected future costs and Relevant revenues are expected future revenues that differ among the alternative courses of action being considered. To be relevant costs and revenues MUST: 1. Occur in the future every decision deals with selecting a course of action based on its expected future results. 2. Differ among the alternative courses of action costs and revenues that do not differ will not matter and will have no bearing on the decision being made.

For a company like Precision sporting goods and their plan to reorganize their manufacturing labor department, all other costs and revenues are not going to change by reorganizing and thus are irrelevant. This saves a lot of confusing and prevents any human error by doing so. Historical costs may be helpful in making informed predictions (our historical data of 14/hour helped out realize our new expected manufacturing labor costs) they are from the past and irrelevant (SUNK). Understanding which costs are relevant and which are irrelevant helps the decision maker concentrate on obtaining only the pertinent data and is more efficient. Qualitative and Quantitative Relevant Information Quantitative factors are outcomes that are measured in numerical terms. Some can be financial while others nonfinancial. Examples include reduction in new product-development time and percentage of on-time flight arrivals. Qualitative factors are outcomes that are difficult to measure accurately in numerical terms. Example: employee morale. Relevant cost analysis generally uses financial quantitative factors BUT nonfinancial quantitative and qualitative factors are not unimportant. For example, in the Precision sporting goods example, managers had to factor in the effect of possible lower employee morale

An illustration of Relevance: Choosing Output levels

The concept of relevance applies to many decision situations. Including one-time-only special offers, and potential problems in relevant-cost analysis. One-time-only Special Orders One time only orders refer to special orders offered to a company when there is idle capacity and no longrun implications. Example: Surf Gear manufactures quality beach towels at its highly automated Burlington, NC plant. The plant has a production capacity of 48,000 towels each month. Current monthly production is 30,000 towels. Retail department stores account for all existing sales. Expected results for the coming month (August) are shown below (these are predictions based on historical costs). As a result of a strike at its existing plan, Azelia, has offered to buy 5,000 towels from Surf Gear in August at $11 per towel. No subsequent sales to Azelia are anticipated. No Marketing costs will apply to this special order. Relevant cost analysis: Revenue: 5000 x 11 = 55,000 V-Manuf Cost: 5,000 x 7.50 = 37,500 CM: 17,500. Surf Gear should accept the offer since NI increases by 17,500.

Potential Problems in Relevant Cost Analysis Two problems managers should avoid: 1. Watch for incorrect general assumptions, such as all variable costs are relevant and all fixed costs are irrelevant 2. Unit-cost data can be potentially misleading to decision makers. Best way to avoid these two potential problems is to keep focusing on 1) total revenues and total costa (rather than unit revenue and unit cost) and 2) the relevance concept. Managers should always require all items included in an analysis to be expected total future revenues and expected total future costs that differ among alternatives.

Insourcing-versus-Outsourcing and Make-versus-Buy Decisions

Outsourcing is purchasing goods and services from outside vendors rather than producing them in house. Insourcing is when you dont provide the same sources from an outside company (assigning an employee to do the same work in house). Make or buy decision: the choice managers face when deciding whether to outsource or make at the plant. Example 2: The Soho Company manufactures a two-in-one video system consisting of a DVD player and a digital media receiver. Soho plans to sell 250,000 units in 2,000 batches of 125 units each. Variable batch costs are 165/batch Strategic and Qualitative Factors By choosing to build items in house a company retains control of how much to make and doesnt have to deal with price disputes. However while outsourcing a company becomes lean and has the time and resources to focus on other areas. Sometimes a company might enter into a long term contract to avoid the supplier changing prices. International Outsourcing When going international companies need to keep the currency exchange rage in mind as it can affect how one views costs. Also the economic condition in the specified country.

Opportunity cost: contribution to income that is forgone by not using a limited resourse in its next base alternative use.