As you can see in this figure,
the price elasticity of demand,
measures the sensitivity of product demand to price changes.
And if the price elasticity of demand is greater than one,
that's called elastic demand,
a percentage increase in the price will lead to
an even greater percentage decline in the quantity demanded.
In such a case,
a price increase will actually lead to
a decline in the firm's total revenues. That's right.
If demand is elastic,
a price hike will actually lead to a decrease in
the firm's revenues rather than an increase.
Now, there are several key points that are often not taught in micro-economics courses.
First, the price elasticity of demand is not immutable but rather,
changes over the course of the business cycle.
Second, as the recession takes hold,
the price elasticity tends to rise and become more elastic.
This makes product demand more sensitive to any price hikes,
so that a price hike during a recession is more
likely to reduce total revenues rather than raise them.
So, the strategic management rule of thumb here is to lower prices going into
a recession and raise them only during sustained economic expansions.
In a recession, where profits are being squeezed and cash flow might be tight
the knee-jerk reaction of many business executives is
to slash advertising and batten down the hatches.
The typical result is to accentuate
the falling product demand and see revenues decline even further and faster.
In contrast, the strategic business cycle manager will counter
secretly increase advertising during a recession for several reasons.
For starters, increased advertising will help slow or
minimize the decline in product demand as the recession deepens.
And, may even stabilize or increase that demand.
Second, and more importantly from a strategic view,
advertising costs generally are lower during
recessions while the market is less cluttered as other firms cut their advertising.
This makes a recession a great time to use increased advertising,
to build a product's brand or the brand of the business itself.
The strategic rules of thumb here are simple,
sell value during recessions and slow growth periods and
sell style during robust economic expansions
when consumers are confident and flush with cash.
In this way, a business' messaging should strategically change
with the business cycle seasons.
Let's turn now to the operations in supply chain management team.
And, here some of the key decisions include,
how much to produce,
how much product inventory to hold
and as a key part of the supply chain management function,
how much inventory of the various production inputs should the firm have on hand,
for the production process?
So, let's run another scenario here.
Your forecast says, a recession is coming.
Do you increase or decrease production?
And, how will your inventory levels for both your product and production inputs change?
Again, take a few minutes to jot down your thoughts on this,
and this time be sure to write down the logic of your decisions
along with your answers.
When a recession hits,
it is of course costly to be caught with large amounts of product inventory.
It can be equally costly from a foregone revenue point of view,
to be caught with too little product inventory as the economy recovers.
So here's a good strategic rule of thumb.
The executive team should begin to both cut production and
trim inventories in anticipation of a recession.
And, when the forecast is for economic recovery,
the executive team may begin to increase production and build
inventories in anticipation of that recovery and ensuing economic expansion.
Of course, a similar logic holds for managing input inventories.
Large, unused stockpiles of various inputs used in the production process can weigh
down the bottom line as
the business cycle slides from the late expansion into early recession.
And, such excess input inventory can be
all the more costly because a company will likely have paid
premium prices for these inputs at
the late expansionary stage of the business cycle under conditions of robust demand.
So, the sound supply chain management strategy here is to
simply trim input purchases in anticipation of a recession,
just as the company is cutting back on production.
And if the executive team forecasts a recovery,
the supply chain managers should begin to increase input purchases,
so as to be ready for increased production.
Okay, that is a most excellent start to
our analysis of various business cycle management strategies.
So let's take a quick break now.
And when you're ready, let's move on to the topics of capital investment,
corporate finance, and credit management.
Dr. Peter NavarroProfessor
