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Managerial Economics

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The company should hire new workers to handle increased demand for our products. If the company hires new workers, there is a great possibility of the company being unstable. There are many factors to consider when making such decisions. These decisions are based on clear criteria like the marginal costing and break-even analysis. The most appropriate method of choosing between the two methods is using a comparative revenue and cost sheet. This is basically the methodology adopted.

Should our company hire temporary workers or hire new workers to handle increased demand for our product? In absolute terms, this is a question of great importance. In a sense, the issue of labor is very fundamental when it comes to production and selling decisions. When we are making decisions, we look into the relevant cost (incremental) costs that affect the decisions of the company. Labor forms part of the prime cost. Prime cost is relevant and incremental and it will directly affect the decision-making in the company.

We do not however put into consideration the fixed costs of the company. This is because the fixed costs are non-incremental and irrelevant. The computation applicable in this case is computing the contribution (contribution is the difference between the net sales and the prime cost in the company. Prime cost is more or less the direct cost). The important question we are dealing with is whether we should outsource labor, in terms of hiring temporary workers or we should employ new permanent workers. Our criteria for decision will be to choose the alternative that yields more contribution. After the calculating contribution, we subtract the fixed costs from the value to find out the profit that will result from the new structure of labor.

We can choose to hire the temporary workers to take care of the increased demand. In this case, the workers will work under some short-term contracts, which will expire and lead to their dismissal. The other option will be to hire permanent new workers who will sign permanent job contracts. These contracts can be perpetual or renewable. These new permanent workers will be in the company payroll as a permanent direct cost

Below are some factors and costs relevant to the question.

Costs

The costs involved in this decision will be the cost of recruiting the temporary staff, in terms of time and money and the actual wage costs. This is because even if they are going to be just temporary workers, they need to deliver quality services to the organization to make sure those customers are satisfied leading to the sustenance of the increased demand.

Labor availability guarantee

If the temporary workers are trained and taken on board, they are going to work for the company only for some short period and then their contracts will expire. The problem is that we cannot be sure that the next time we need to outsource labor, the same people we trained in the first time will be available.

Uncertainty

There are high chances that the workers we trained and released when the demand was over will already be committed elsewhere by the time we need them again. That being the case, the company will need to train new temporary workers which will take time and cost. This creates a recurrent training cost in the company. Again, this decision assumes that the increased demand is also temporary. The assumption fails if the increased demand does not subside with time

Mitigation of cost

The advantage of hiring new permanent workers, as opposed to the temporary ones is that once they are trained, they become functional most possibly for a long period. This greatly reduces, if not eliminates the recurrent training cost. Furthermore, the recurrent time taken on staff recruitment will be reduced. The problem with this decision is that it is based on the assumption that the increased demand will continue perpetually.

Risk of Redundancy

In the case of temporary workers, the risk of redundancy is not there because if the demand goes down, the additional workers will simply be laid off. The risk will crystallize if the additional workers are permanent and the additional demand goes down.

Terms of the additional cost

If we settle at hiring permanent workers, there will be a one-off recruitment cost, additional staff motivation cost and increased salaries in the company. If we decide to hire temporary workers, we subject ourselves to a recurrent training cost, as we cannot be sure that exactly the same people we trained will come back.

The labor structure in the competing companies

It is important to note that the competing companies are in the same economic environment. This means that if a particular labor structure did not work for them, it will be unlikely that the same will work for this company. This is because in a competitive market structure, the rules of the game are not set by any individual firm

The long term cost comparison between the two alternatives

The long-term period is very important as far as this decision is concerned. This is because we assume that the business is a going concern (it does not have any intentions to curtail business in the near future). I a decision is not favorable in the short run, then it is not worth being made

The consistency concept

It is important to note that the decision that we make should have the capacity to obey the consistency concept. In this regard, the decision arrived at should remain viable for a reasonable period. What time is reasonable is a matter of fact to be decided of course considering the business circumstances at the time of decision. If the decision is subject to sudden incidental changes, then it will be unsafe for the company to adopt it. The importance of obeying the consistency concept is to facilitate trend analysis in future to be able to form reasonable projections for strategic planning.

Materiality concept

This is a question of how material the labor cost is as compared to the total direct cost of the business. If labor forms a very substantial proportion, say 40 – 60% then a deep financial analysis will be needed.

It is important to note that some of these factors cannot be measured in absolute terms but they will of extreme importance in this study. A measurement description is given below:

 Cost

The cost of labor should be measured in accordance to the applicable labor laws. In this case let assume that the incremental labor cost will be 20%. We compute the 20% of the existing labor cost and apportion the wages to the new workers according to their expertise. For instance, let us take the existing labor cost to be $100, 000. This means that we shall have $20,000 additional labor to pay for

 Labor availability guarantee and uncertainty

The question will be whether if we outsource the 20% extra labor temporarily, we shall be able to maintain the same if the same problem arises again. Unavailability might mean a higher outsourcing cost. We can quantify uncertainty stochastically by coming up with appropriate probabilities. To achieve this, we need to carry out a labor market survey

 Mitigation of Cost

In this case, we prepare a comparative implicit and explicit cost sheet for the two decisions. It will be prudent to choose the alternative that minimizes implicit costs. In this regard, we consider both the short-run and the long-run periods. Every business aims at maximizing profits and therefore we should not allow the cost to escalate unreasonably.

 Risk of redundancy

There are many ways of determining the productivity of a worker. Any worker should deliver at least an amount of work commensurate to the pay package. An easy way of determining the productivity of a worker would be to use the time rate method. Payments should be done according to the number of hours worked, according to the workers’ timesheets. In this case, we can compute salary as follows:

Salary = (Hours worked in a month) / (Total official hours per month)*Monthly rate

The long term cost comparison between the two alternatives

A spreadsheet should be provided showing the comparative cost between the two decisions.

We can let scenario 1 represent the choice to hire temporary workers and

Scenario 2 represents the choice to hire new permanent workers

ANALYSIS

The economic reasoning applicable in this case will entail marginal costing and decision-making, the Cost Volume Profit Analysis (CVP) and the break-even analysis. As much as we want to use the contribution method, we must make sure that at the least, the fixed cost equals the contribution. (The fixed asset contribution ratio should be at least 1).  The analysis will take the following format.

Item                                                                                                                           Amount

Total Sales                                                                                                                 XXX

Less: Sales returns                                                                                                     (XX)

Net sales                                                                                                                   XXX

Less: PRIME COST

Direct materials                                                                                                          (XX)

Direct labor                                                                                                                (XX)

Contribution                                                                                                               XX

The alternative with the highest contribution is more viable. In my opinion, it will be more viable to hire new permanent workers.

SUMMARY

The question as to whether we should hire permanent new staff or engage some temporary workers will be determined as above stated. The recommendations below should be followed:

  • The other factors cannot be measured objectively but they are of paramount importance.
  • The relevant figures should be inserted in the spreadsheet provided so as to come up with comparative data
  • A good labor structure should be implemented to make sure that as a worker goes up the ladder, he works accordingly. It is known in economics that labor has a regressive supply curve. This is because as a worker goes up the hierarchy, there is always the tendency to be lax. The following curve illustrates this fact

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