Problem:
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 automaker 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 breakeven point. And this increase would continue even if the automaker cut back its orders to the original level.
Q1. What options are available to the company?
Q2. What would you do if you faced the same situation?
Q3. Would you buy the product from your competitor to meet the contract? Explain.
Q4. Would you add the additional capacity? Explain.