CH6:Types of Market and Cost Effects

Question 1

What are the 5 types of cost?

Answer 1

1) Fixed costs
2) Variable costs
3) Total costs
4) Marginal costs
5) Average costs

Question 2

What is a fixed cost?

Answer 2

costs that do not change with the level of output
e.g. rent, advertising, salaries, banking/legal fees ie. even if the business does not have any sales, it will still incur costs such as rent.

Question 3

What is a variable cost?

Answer 3

Costs that vary depending on the level of output - raw materials, distribution costs, energy costs, direct labour costs.

i.e. as output levels increase, the variable costs increase too

Question 4

what are Total costs ?

Answer 4

Fixed costs + variable costs

note. graphically, total costs need to start at the point of fixed costs as these need to be paid no matter what

Question 5

What is a marginal cost?

Answer 5

The amount by which total costs increase with each additional unit of output (goods or services made)

Question 6

What is average costs?

Answer 6

Total costs divided by the level of output i.e. total cost per unit

Question 7

How is price often determined?

Answer 7

Using average cost for the specified level of output as a basis, plus the required profit margin

Question 8

Definition: outsourcing

Answer 8

the contracting of ALL or PART of the business operation to an external organisation

Question 9

What are ADVANTAGES of outsourcing?

Answer 9

known FEE - a price for the work is agreed upon in advance

Lower COST and higher QUALITY - high expertise of the external provider

Question 10

What are DISADVANTAGES of outsourcing?

Answer 10

Loss of control

Unlikely to gain a competitive advantage - if other competitors use the same external providers

Companies become too dependent on the external provider - hence vulnerable to price rises or refusal/failure to provide the service

Lose internal expertise - hard to bring expertise back in-house and no longer an intelligent customer when negotiating future contracts

The external provider has a limited understanding of the business - hence suboptimal service provided

Loss of confidentiality - external parties require access to internal systems

Question 11

What is a helpful way to help make decisions on if you should outsource for a certain task?

Answer 11

by categorising a business’s tasks in terms of the nature of their competency

Question 12

What are competencies?

Answer 12

The skilled processes in an organisation

Question 13

What are the 3 categories of competencies? and can they be outsourced?

Answer 13

1) Core competencies - essential to the business maintaining its competitive advantage. should NOT be outsourced.
2) Complementary competencies - very important, but not key to competitive advantage. can sometimes be outsourced but to an expert in the field.
3) Residual competencies - not directly linked or essential to business operations e.g. payroll. can be easily outsourced.

Question 14

Depending on which tasks are outsourced, the structure of the business changes, what are two standard business structures?

Answer 14

Network organisations

Virtual organisation

Question 15

What are features of network organisations?

Answer 15

Network organisation depends to a large extent on the relationships it builds with other parties.

The organisation aims to keep directly employed staff to a minimum (keep costs low). It arranges for its activities (e.g. IT, finance, design, production) to be outsourced with the role of the organisation being to co-ordinate the outsourced activities.

The organisation tend to keep the key drivers of its ability to compete/core operations ‘in-house’

It is more flexible than a traditional organisation - ie. can easily increase or decrease capacity through using outsource company

They may also rely on strategic alliances with other firms in order for the organisation to be a success (eg. in R&D of joint products)

Question 16

What is a virtual organisation?

Answer 16

Uses IT as the main communication tool between employees and contractors

Staff or contractors may be located in geographically dispersed locations communicating via IT solutions

Question 17

What is transaction cost theory?

Answer 17

It states that ALL costs associated with OUTSOURCING should be recognised and taken into account, not just the contract fee, when deciding whether to outsource the task or not.

Transaction cost theory helps companies decide whether to OUTSOURCE (aka MARKET Solutions) or EMPLOY people (aka HIERARCHY Solutions)

Question 18

In terms of transaction cost theory, what are some transaction costs to outsourcing?

Answer 18

Contract negotiation whenever circumstances change
Monitoring of the quality of the outsourced work
Possible legal costs on non-conformance to contract

Question 19

What are 2 factors affecting how significant the transaction cost is likely to be?

Answer 19

1) Asset specificity

2) Bounded rationality

Question 20

Definition: Asset specificity

Answer 20

How specific an asset is to one particular area of work.
the more specific it is the higher the transaction costs will be hence more likely to be kept in-house

eg. an employee with a high level of knowledge in a specific area or a piece of equipment with only one application

Question 21

Definition: bounded rationality

Answer 21

The idea that when making outsourcing decisions, individuals are confined by 3 constraints:

1) A limited amount of time
2) The limited capacity of the human mind
3) The limited info available

Due to these constraints, it is possible that the external providers chosen by the company may not produce work of high enough quality and hence the work will have to be redone. The cost of this must be added in to the transaction costs.

Question 22

What are 2 alternatives to outsourcing (other ways to reduce transaction costs)? and explain what they mean?

Answer 22

1) Shared service organisations - created when any repeated services throughout the organisation are put into one division to serve the whole organisation - eg. HR, IT and accounting
2) Flexible staffing

Question 23

What are pros and cons to shares service organisations?

Answer 23

Pros: avoid duplication of staff and tasks performed

Staff performing the same functions for the entire organisation increase expertise and efficiency

Negatives: The level of efficiency will depend on how well the organisation is set up and ALSO the effectiveness of COMMUNICATION between departments

Question 24

What are the 3 routes that Flexible staffing can be achieved?

Answer 24

1) Employment agencies - workers employed on a temporary basis and remain on agency’s payroll
2) Leased employees- employees are still employed through the agency, but on a more ongoing basis/longer term (still on the payroll of the agency)
3) Contractors - employees work on a freelance basis being employed on fixed term contracts to complete specific tasks

Question 25

What are pros to flexible staffing?

Answer 25

Pros - potentially reduced costs from:

Not having to recruit directly - less staff time spent on recruitment, no job ad fees or interview costs

Company only pays when staff are needed

Internal staff not paid overtime

Payroll performed elsewhere

No long term staff development costs

Question 26

What are negatives to flexible staffing?

Answer 26

Less loyalty to the company, hence possibly lower quality of work

Higher hourly rate than paying for staff directly