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Permanent vs. temporary changes in production

Costs will typically react differently under production increases, production decreases, permanent changes, and temporary variations. Costs are also product dependent.

Case 1.4:

Rank Xerox has a number of issues worth contemplation concerning the number of service mechanics involved in different situations:

a) Under a permanent change in number of copiers

o If the number increases, training of new service mechanics will be initiated, so that they after 6-9 months the level will be appropriately adjusted to what is equally as efficient as the current level of mechanics.

o If the number decreases, the least efficient surplus mechanics will be laid off, which can take 3-6 months.

b) A temporary change in the number of copiers

o If the number increases, the most likely outcome is the use of overtime for a period, combined with the anticipation of hiring new people. There might be re-deployment within the organization of people who can easily be trained for the job.

o If the number decreases, there will be no laying off of workers, because of the time it takes to re-educate workers and the insecurity involved in rehiring the same level of qualified workers. These workers will typically be employed elsewhere during this period. As laying off workers is quite costly, the solution will most often be an attempt to sell more copiers. This argumentation seemingly applies to all copier-manufacturers, and a tactical progress will have to be analyzed.

i.e. the difficulties of reestablishing an important knowledge capacity or production is crucial in the adaptation flexibility.

Discussion of fixed and variable costs

The classification of fixed and variable costs makes room for difficult discussions, especially between decision makers (managerial economics) and accountants (financial control/management accounting), as the decision-making occasion in a control-situation is not as variable as in a decision-situation.

The basis of the discussions is the fact that they work with ex post registrations (historic) and ex ante decision-making occasions ("what-if "). Also, decision makers can be presented with many decision-making occasions for which it is unreasonable to expect that the accounting system can deliver data. Finally, decision makers are, because of the mentioned management assignments, often distinguish between fixed and variable costs, while accountants distinguish between capacity costs and unit costs, which are defined below:

o "Capacity costs are the costs that result from capacity. Average variable costs are costs that result from a specific transaction of goods"

This basic difference in definition of cost is rooted in the purpose of the costs.

The decision makers' distinction between fixed and variable costs is applied in calculating tasks concerning e.g. optimization of price or quantity, often with different time horizons, long-term price lists, short-term price competitions, frequent adaptations in capacity, both increases and decreases, different worker capacity for knowledge storing, and different products.

On the other hand, accountants' distinction between overhead fixed costs and average variable costs is applied in relation to external financial reporting, internal analyses, and internal control, e.g. predicting calculations and result-documenting calculations. Naturally, there are limits for the number of perspectives that can be applied in a single accounting and registration system; if these limits are not clearly delineated, then a massive information overload results.

The following is a simplified example of this discussion:

It is a common notion among decision makers that fixed costs, depending on decision situation and time horizon, can be spread on the costs-bearing products and thus be regarded as variable. This understanding relates to Robert Kaplan: "I'd say that, for most purposes, all costs should be considered variable." Accountants on the other hand, regard the spreading of fixed costs (capacity costs) on the products as a mortal sin. The argument is that the spreading of fixed costs results in the closure of products, which within the financial period creates a positive contribution margin. Products that create a positive contribution margin should not be closed down, considering that any contribution margin that covers fixed costs is better than no contribution margin. Michael Andersen and Carsten Rohde have appropriate input at this juncture: " difference between sales income and variable costs can be expressed by means of the contribution margin... in this way it becomes a central result-term in controlling the profitability of the firms different activities"

Another essential argument for not adding the fixed costs in optimization analyses is that the optimization theory (marginal costs = marginal revenue) shows that this results in solutions that are not optimal. The snake in this paradise is that MC is difficult to understand , as the time horizon can be uncertain.

This discussion between the micro theorists and those adhering to Activity Based Costing by Robert Kaplan, is not yet concluded. There are many arguments and case-studies from both sides. It is not the objective of this paper to solve this discussion. As everybody has such a hard time agreeing, I have to accept that: "It depends on the decision situation and horizon."

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