Analyzing Mettoo Company's Shutdown Decision: An Economics Report

This report provides an analysis of the shutdown decision faced by Mettoo Company, a shirt manufacturer operating in Singapore. The analysis considers both short-run and long-run economic perspectives, examining the impact of production costs, specifically average variable cost (AVC) and aver...Read More

ACCOUNTING

Table of Contents
QUESTIONS.................................................................................................................................................1
(A). View...................................................................................................................................................1
(B). Information requirement for shut-down decision...............................................................................2
(C). Risk assessment..................................................................................................................................3
(D). Individual contribution.......................................................................................................................4
REFERENCES..............................................................................................................................................6

QUESTIONS
(A). View
As per the case study, Mettoo company is producing shirts in its Singapore based plant. It
sell shirts currently at £15 each unit however, the cost of production is £18 per unit including
average fixed cost (AFC) of £4 and average variaable cost (AVC) of £14 each shirt. Shutdown
point indicates the minimum or lowest price that an entity requires to justify their continuance in
the market. Considering the short-run period, a firm should continue their production, till the
time, average revenue covers average variable cost. In other words, if the P ≥ AVC, then
company must resume production or vice-versa (Antolin-Diaz, Drechse and Petrella, 2017). In
the given case, price is £15 above AVC of £14, hence, in my opinion, Metto Company must
continually run their production activities of Shirt at Singapore factory. It is because, in the
short-run, it is uneasy to avoid fixed cost, hence, production should not be closed untill and
unless price fall below AVC.
Figure 1 Shut down point in short-run &long-run
(Source: Shut Down Point, 2016)
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Above illustration present that at P2, P= AVC, thus, below these point (P< AVC )shows
shutdown zone in short-run.
By contrast, exit is a long-run decision wherein firm left the industry, avoided all the cost
including both variable & fixed and freed all the resources and capital in other profitable
purpose. In such period, if price is above long-term average cost (P ≥ LRAC ), then firm must
continue otherwise, if P< LRAC, then it must exit (Cheung, Yang and Stobart, 2017). As in the
case, Metto Company’s each unit average cost is £18 above the price of £15, hence, it is advised
to the firm to exit from the industry. Above illustration presented that at P1 price, P= AC at
where, firm is getting normal profit, hence, before the point, where P< AC indicate
shutdown/exit point.
(B). Information requirement for shut-down decision
There are many things needs to be considered before making final shut-down decisions.
As discussed earlier, that in the short-run period, firms are unable to close down their fixed cost
therefore, only the AVC is taken into consideration for shut-down decisions as it must be below
price. However, in long-run, firms are able to mitigate their total cost, therefore, both fixed &
variable costs are considered and price must be above total cost for continuance of production
otherwise vice-versa. Thus, it becomes clear that in order to determine whether Mettoo Company
should shut-down or not Shirt production in short-run, it must compare price with AVC and
ignore fixed cost as it would even incur it at zero level of output. However, long-run period
requires comparison of both the price and average cost.
If Mettoo Company is a one-product manufacturing firm, then, if company would
temproarily seize their shirt production, then, in such case, it would be unable to generate any
revenue as shirt is the single revenue stream of it. As a result, it would be tough for the
establishment to come back into the industry. It is because, during seize period, company would
not take part in production and market supply, as a result, it will loss their consumer base, market
share and their contribution in the supply (Rose, 2017). Customers will start buying shirts from
other producers and company will loss its brand equity totally. Hence, it is better to suggest firm
that before making final decision, multitude of factors must be considered including consumer
base, their product portfolio, revenue stream, market share and others. In addition to this,
temporary shutdown may have disastrous impact for professional relationships, that entity has
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forged. Moreover, company may lost its talented and skill workforce and in future, it will not be
possible to hire them again (Johnson, 2017).
On the contrary side, if it is a multiproduct firm which is engaged in producing multiple
of items and has diversified business operations is able to take shut-down decisions so strongly.
The reason is their revenue stream is widen and closure down of one item will not have a
materialistic impact over their income generation. However, still, there are numerous
components that an entity must consider like contribution of every item to the total revenues. For
instance, if Mettoo Company is assumed as a multi-product firm, however, majority of the
customers purchase only the shirt from it, then, in such circmustance, it could not seize its
production easily otherwise, a significant client base will be lost. In addition, its best quality of
material, design and technologies used for the manufacturing of shirt may be a reason for its
exceeding client expectation (Rose, 2017). Due to these, purchasers may also prefer buying other
items of it, hence, disclosure of Shirt production at Singapore factor will result in loss of
considerable market size and market share. It is because, customer will switch to its competitive
firm. As a result, company will loss its customer base and lost considerable proportion of
revenues. Taking such risk will have disastrous consequences on the business and affect its
competitive position to a large extent. Due to loss of market share and brand position, Metto
Company will not be able to defeat rivalry firms.
(C). Risk assessment
Risk assessment is the procedure of quantifying risk taking into account their severity and
likelihood of occurence to know risk score and thereafter, putting corrective measures to mitigate
the same (Dabbagh and Sheikh-El-Eslami, 2016). With reference to the shut-down decision of
shirt manufacturing at Singapore plant of Metto Company, different kind of risks conseuqnces
and possibility of occurence are determined below with their respective mitigation action as
follows:
Risk aspects Likelihoo
d of
occurence
Severity Risk score Mitigation
Loss of revenue High High Unacceptable Introducing new item with the
closure down of shirt will be an
attractive opportunity for the
Mettoo Company to retain their
customer base and develop new
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revenue stream.
Loss of talented
labor pool
Low Medium Low Training & development will
enable firm to build talent and
capabilities in new workforce.
Brand loss Medium High Medium All the consumers will serve with
the best quality new offerings with
aggressive marketing campaign.
Competitive
disadvantage
Low High Medium Loss of customer & market share
will be covered by providing other
sound quality products at right
prices, so as to gain success in the
market.
(D). Individual contribution
The coursework greatly helped me to gain conceptual and practical knowledge of
economic shutdown decisions in both short-run and long-run theory and how it works. With the
help of it, I became able to come to a final decision to advise Mettoo Company about not closing
down its maufacturing in short-run whilst in long-run, it should shut down because of lower
prices than average cost. Despite this, additional search on website helps me to identify mutitude
of factors how they will impact business decisions such as loss of customer base, market share,
brand position and competitive strength. It enable me to gain thorough knowledge of its
practicality in the real world. It improved research skills, theoretical knowledge and analytical
skills as I compared both the short-run and long-run period and analyze their reason behind
differences. As the shutdown decisions is a risky factor therefore, different types of risks had
been recognized and their consequences and likelihood has been ranked as High, Low and
Medium to provide risk score to every element. On such aspect, a risk mitigation plan is
designed to combat all kinds of risks involved. Thus, the study greatly helped me to improve
planning and decision-making skills with justifications.
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REFERENCES
Books and Journals
Antolin-Diaz, J., Drechsel, T. and Petrella, I., 2017. Tracking the slowdown in long-run GDP
growth. Review of Economics and Statistics. 99(2). pp.343-356.
Cheung, Y.H., Yang, Z. and Stobart, R., 2017. The Position Control of a Gasoline Engine during
Shutdown. SAE Technical Paper. 14(3). pp.19-38.
Dabbagh, S.R. and Sheikh-El-Eslami, M.K., 2016. Risk assessment of virtual power plants
offering in energy and reserve markets. IEEE Transactions on Power Systems. 31(5).
pp.3572-3582.
Johnson, R.D., 2017. The Demand for Labor. In Rediscovering Social Economics. Springer
International Publishing. 14(5). pp. 121-131.
Rose, A., 2017. Economic Framework. In Defining and Measuring Economic Resilience from a
Societal, Environmental and Security Perspective. Springer Singapore. 14(7). pp.7-17.
Online
Shut Down Point. 2016. [Online]. Available through:
https://www.tutor2u.net/economics/reference/perfect-competition-the-shut-down-price.
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