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Analysis of Firm’s Losses

MOHIT WADHWANI
PRASHUN KUMAR JHA
SHASHIRAJ R
TANVI BANSAL

Part I (10 marks)

  1. You run a small firm. Two management consultants are offering you advice. The consultant A says that your firm is losing money on every unit that you produce. To reduce your losses, the consultant recommends that you cut back production. The consultant B says that if your firm sells some additional units, the price will more than cover your increase in costs. In order to reduce losses, the second consultant recommends that you should increase production.

Explain which consultant/s is/are factually true and who is offering the correct advice?

Explain your answers by drawing the relevant diagram/s.

SolutionIn the figure below, note that at quantity Q1, AC> Price, (point ‘a’ is above point ‘b’) so the firm is making a loss. Loosely speaking, therefore the first consultant could be said to be correct that the firm is losing money on every unit that it produces.

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At Q1, however the price is greater than MC (point ‘b’ is greater than point ‘c’), thus, the second consultant is correct that if the firm sells some additional units, the price will more than cover your increase in costs.

 C:UsersSHASHIRAJ RDesktopUntitledvd.pngC:UsersSHASHIRAJ RDesktopMicro.png

The diagram above shows that it is the second consultant who is correct. To make profit the firm should produce until Price (P) = MC which means producing until point d. If the firm does this then the losses will turn into profits.

Part II (20 marks) (maximum word limit 1500, tables/graphs additional)

Competitive forces in the market ensure that today’s big firms will not remain market leaders always.

  1. Using data from 1990 to 2012 for the Fortune 500 list of the top corporations in the United States, illustrate how companies fall behind when they stand still, but when they innovate they can leap ahead of the competition
  2. Investigate the history of any two of today’s top 30 firms (year 2012). How quickly did they rise through the top 500 rankings?

Download data the top 500 for every year from 1990 to 2012 from:

http://money.cnn.com/magazines/fortune/fortune500_archive/full/1955/index.html.

Solution 1:

History of Yahoo and Google 

Yahoo!: Yahoo was created in 1994 with an earlier name of “Jerry and David’s guide to the World Wide Web”. The site was a directory organized to work as a searchable index of other websites and pages. Later the name was changed to Yahoo! (Yet another Hierarchically Organised Oracle). Yahoo grew rapidly in 90’s and the stocks were skyrocketing.

Google: Google was founded in 1998(4 years later than Yahoo). Google was launched as a search engine to look for other websites over the internet, which later grew drastically with various product lines added to it.

Comparison of Yahoo and Google

Revenue (in billions) generated by Google and Yahoo in the time period of 2005-2012 is as follows:

Year Google Yahoo
2005 6.14 5.26
2006 10.6 6.43
2007 16.5 6.97
2008 21.79 7.21
2009 23.65 6.46
2010 29.32 6.32
2011 37.91 4.98
2012 50.18 4.99

The above graph shows the comparison of the total revenues of the two major US based companies, Google and Yahoo during the period 2005-2012. It can be clearly observed that, while the revenue curve of yahoo is very gentle whereas the curve of Google is very steep. This clearly indicates that the revenue of Google is always increasing with the time whereas the revenue of Yahoo is almost stagnant throughout.

Some of the major innovations or decisions that played an important role in the above observations are noted down:-

  • One of the major innovation or idea was of including the advertisement in all its products. This turned out to be a big revenue earner for them. The company reported $10.492 billion revenue from the advertisement segment alone. This was such a boon that in 2011 Google’s 96% revenue was from advertisement. Yahoo on the other hand did nothing big to increase the revenues of the company.
  • In April 1, 2004, Google launched its product Gmail. Yahoo came up with the same idea and launched yahoo mail. Google in reply increased the attachment size to 25 MB along with many other innovation like merging with mobile etc. On the other hand Yahoo kept following the footsteps of Google. As a result Gmail has 425 million users and yahoo lags with 281 million users.
  • The continuous revenue augmentation is not just due to few innovations but the list kept on increasing day by day with Google Calendar (2006), Drive (2012),News(2002) , Play(2008), etc. On the Other hand apart from Yahoo Finance and Yahoo News no other significant innovation was made by Yahoo which initially raised the revenue of yahoo from $10 million to $110 Million but later on it became stagnant and gradually taken over by Google News.
  • Along with the major innovation some great decisions of acquisition too helped Google earn more. Major acquisition includes keyhole Inc (2004), double click (2007) for $3.1 billion. In 2010, Google Energy made its first investment in a renewable energy project, putting $38.8million into two wind farms in North Dakota. In contrast, the stocks of Yahoo plummeted that other companies like Microsoft tried to acquire Yahoo. After the dot-com bubble burst, Yahoo reached a post bubble low of $8.11 a share from earlier $118.75 a share.
  • In year 2008 till 2011 Yahoo was going through the internal conflicts and restructuring of the company which resulted in the downfall of the revenue and market price. On the other hand Google came with the new innovation of Android Operating System which has completely changed the definition of mobile phones in the market and has been successful in acquiring the mobile market by large chunk of 40%.

Solution 2:

Valero Energy Corporation

  • “Valero Energy Corporation”is a Fortune 500 international manufacturer and a marketer of transportation fuels, power and other petrochemical products.
  • The company owns and operates 16 refineries throughout the United StatesCanada" target="_blank" rel="nofollow noopener noreferrer">CanadaUnited Kingdom, and the Caribbean with a combined throughput capacity of approximately 3 million barrels (480,000m3) per day, 10 ethanol plants with a combined production capacity of 1.2billion US gallons (4,500,000m3) per year, and a 50 megawatt wind farm.
  • Valero is also one of the United States’ largest retail operators with approximately 6,800 retail and branded wholesale outlets in the United States, Canada, United Kingdom, and the Caribbean under the Valero, Diamond Shamrock, Shamrock, Ultramar, Beacon, and Texaco brands.
  • Valero’s roots grew out of the 1970s energy crisis. At a time when San Antonio used natural gas to fire its power plants, the natural gas subsidiary of Houston’s Coastal Corp. jacked up prices, enraging city officials and residents.
  • Since the 1979 spinoff, Greehey, an outsized personality and bold leader, transformed Valero from Texas’ largest intrastate pipeline company into North America’s largest refiner.
  • In 2006, Greehey ceded the CEO reins to Bill Klesse, a less flashy but exacting Valero executive. Under Klesse’s leadership, Valero’s 2012 revenue of $138.3 billion earned it a spot on the Fortune 500 top 10. The company now has 16 refineries, 10 ethanol plants, 10,500 employees and a wind farm. The graph below explains the rise:

C:UsersSHASHIRAJ RDesktopVel.PNG

  • It wasn’t always smooth sailing for Valero. It had suffered quarterly losses in a notoriously volatile business, where the see-sawing price of oil — what refiners buy to make fuels — directly affects profit margins.
  • Greehey’s strategy was to build sophisticated units at some plants that could process heavy crude oil that was cheaper to acquire than light, sweet crude.
  • Greehey also went on an acquisition spree. By the mid-1990s, refining was at the bottom of a cycle and refineries were cheap. They could buy at 10 cents on the dollar.
  • The turning point for Valero came in 2000, when it bought Exxon’s Benecia plant in Northern California, its most profitable refinery. Exxon had to sell the plant when it bought Mobil.
  • Valero suffered through difficult years in 2008 and 2009. Demand for its products plummeted and its profit margins evaporated. “Our cash was going out the door,” Klesse said.
  • Valero addressed its problems by shutting down a refinery and selling two others, in addition to borrowing money. It took advantage of other companies’ distress by buying ethanol plants on the cheap.
  • Decision to spend $3 billion in the past three years to build two refining units called hydrocrackers, which break down heavy crude oil into lighter products including diesel and gasoline. One is operating now, and the second will be fired up this year.
  • Hydrocrackers will boost Valero’s production of diesel fuel, which Gheit said earns higher profits than gasoline and is the fastest-growing in terms of global demand. “He’s making good investments.”

Social Factors

The list of Valero’s giving is long. For 2012, direct donations from the Valero Foundation totaled $13 million, while the 2012 Valero Texas Open/Benefit for Children raised $9 million. Employee and company contributions to the United Way last year came to $11.6 million.

AT&T

  • AT&T’s (T) Cingular Wireless unit reported the best earnings in its history on Jan. 24, demonstrating that the telecom giant’s aggressive acquisition strategy is working. Once regarded as a clumsy runner-up to rival Verizon Wireless (VZ), former Cingular Wireless owners BellSouth and SBC decided to assert themselves in 2004 with a $41 billion acquisition of the old AT&T Wireless. SBC went on to buy the separate AT&T landline business for $16 billion and BellSouth for $86 billion in separate deals changed its name to AT&T as well.
  • Cingular performed successfully across the board. It reported annual revenue of $37.5 billion, up 9% for the year 2006, and quarterly revenue of $9.8 billion, up 10% for the period. The company added a record 2.4 million subscribers during the quarter, reaching 61 million. Operating margins rose about one-third of a percentage point, to 34.4%. And the percentage of customers who switched to a rival company dropped to 1.8%, down from a problematic 2.1% in the fourth quarter of 2005.
  • The key to future growth is that growing data revenue—that is, revenues from e-mail, text messaging, Web browsing, and entertainment—is finally offsetting declines in older voice businesses. New development was historic. It shows that billions of dollars’ worth of capital investments are paying off. Data revenue is up 69%. The graph below explains it:

C:UsersSHASHIRAJ RDesktopAT&T.PNG

  • Cingular has successfully used its scale and scope to drive down costs. That’s also helped it strike exclusive deals for cutting-edge mobile phones. Cingular scored a coup on Jan. 9, when Apple (APPLE) CEO Steve Jobs introduced the much-anticipated iPhone, a combination mobile phone and iPod, and said Apple would offer the device in the U.S. exclusively through Cingular.
  • Cingular has innovated in the area of mobile entertainment, too. Its new Cingular Music service allows users access to music subscription services such as that offered by Yahoo! (YAHOO). Rivals, including Verizon, have created their own music services.
  • It will begin offering 411 callers searching for a local business such as a dry cleaner or restaurant a text message with ads from establishments located nearby. Subscribers will receive the ads only if they want to view them, Cingular executives told BusinessWeek.com in an interview. Cingular also plans to integrate ads into mobile search, those executives said. Mobile advertising revenue isn’t figured into more earnings forecasts for the company.

Part III (each question is for 10 marks, answer any one question)

  1. Suppose Carrie decides to lease a photocopier and open up a black-and-white photocopying service in her dorm room for use by faculty and students. Her total cost, as a function of the number of copies she produces per month, is given in the table below:

Fill in the missing numbers in the table, assuming that Carrie can charge 5 cents per black-and-white copy.

  1. How many copies per month should Carrie sell?
  1. If the lease rate on the copier were to increase by $50 per month, how would that impact Carrie’s profit-maximizing level of output? How would this $50 increase in the lease rate affect Carrie’s profit? What will she do when it is time to renew her lease?

SolutionThe table would be as seen below:

No. of photocopies per month Total cost Fixed Cost Variable Cost Total Revenue Profit
0 100 100 0 0 -100
1000 110 100 10 50 -60
2000 125 100 25 100 -25
3000 145 100 45 150 5
4000 175 100 75 200 25
5000 215 100 115 250 35
6000 285 100 185 300 15

Ans a) For breakeven, Carrie should at least sell 3000 copies per month because at 3000 copies her profit is minimum as can be seen from the above table. But, to make maximum profit she should sell 5000 copies per month.

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Ans b) If the Lease increases by $50 per month the fixed cost per month rises by $50 which then decreases the profit by $50 making the business unfit for photocopies up to 6000 nos. In this case she would rather not renew her license. This can be understood from the table below:

No. of photocopies per month Total cost Fixed Cost Variable Cost Total Revenue Profit
0 150 150 0 0 -150
1000 160 150 10 50 -110
2000 175 150 25 100 -75
3000 195 150 45 150 -45
4000 225 150 75 200 -25
5000 265 150 115 250 -15
6000 335 150 185 300 -35

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