Question

Eddie & Company: Exceeding the
Relevant Range
Eddie & Company is a small manufacturer located in the North Central part of the United
States. The company manufactures auto and truck axles for automobile producers. Most
of its output is sold to one of the larger auto companies. Because its sales have recently
increased beyond all expectation, that company now wants Eddie & Company to increase
its production level to satisfy the increased demand.
This request poses a serious dilemma for the owners of Eddie & Company. It would
have to considerably increase production in order to ship more axles to the automaker.
However, it has already been operating at full capacity just to meet the demands of its
customers, including the automaker, when sales were low. The only ways to satisfy the
increased demand would be (1) to buy the needed new products from its competitors
and resell them to the automaker—at no profit—or (2) to increase its own production
capacity in order to satisfy the demand.
The first alternative would satisfy the short-run increase in demand, but not the
long-range one. But the second alternative of increasing production capacity would pose

different problems. First, there is no assurance that the increased demand from the auto-
maker will be permanent, and Eddie & Company could find itself with unused capacity.

Second, this alternative would mean increased fixed expenses, which would raise the
company’s break-even point. And this increase would continue even if the automaker cut
back its orders to the original level.

1.What options are available to the company?
2. What would you do if you faced the same situation?
3. Would you buy the product from your competitor to meet the contract? Explain.
4. Would you add the additional capacity? Explain.

Answer 1

1.What options are available to the company?

There are two options available with the company:

• Buy the needed new products from its competitors and resell them to the automaker—at no profit
• Add capacity to increase its own production capacity in order to satisfy the demand.

2. What would you do if you faced the same situation?

Factors to consider:

• In the first option, there is no profit
• We are not sure about the sustainability of the demand in future
• Capacity addition translates into huge upfront cost, additional fixed expenses and hence increase in break even point

My suggestion will be to

• Go ahead with the first option i.e buy from the competitor and resell at no profit
• Defer the capacity addition plan
• Wait and watch how the demand plays around, is it sustainable, going up or moving down.
• Only if we see a sustained level of demand and we have more clarity about the demand say 5 to 6 months down the line, we should then examine the option to expand and add capacity.

3. Would you buy the product from your competitor to meet the contract? Explain.

• Yes, in the short run, this is what I will do.
• I will renegotiate the contracted price though to get some kind of profit.

4. Would you add the additional capacity? Explain.

• Yes, but not immediately
• After waiting and watching for 6 months and studying the pattern and sustainability of demand, I will add the additional capacity.