Case Study on “A Managerial Application of Cost Functions by Rail Road”

Case Study on “A Managerial Application of Cost Functions by Rail Road”

1. Do managers often find it difficult to minimize costs? If so, why?

Yes.

In the process of cost mitigation, there are lots of points to consider. Especially in data collecting
for the cost calculation, most of the managers are struggling due to having a large scale of data.
As an example, in this case study has considered about 200 freight yards and around 12,000
miles of tracks.

Therefore, a manager is willing to reduce cost, firstly he has to understand the cost is imperative.
Because minimizing cost is not basically reducing quality as well as cheating the customer
without giving deserved product or service. Cost can be basically divided as fixed cost and
variable cost.

Most of the managers are unable to identify these two types of costs in their calculations. As per
the case study, fixed charges are excluded. Most of the other costs such as maintenance and
storage cost, vacation cost, repair cost and etc. are not included in the calculations.

Fixed cost is the cost which does not change as the product output changes and variable cost is
the opposite as it changes with the output. As a simple example, raw material of a product can be
taken as variable cost while the monthly electricity bill can be taken as fixed cost. There is an
opportunity cost which is the value of the next best alternative given up in order to get
something.

Majority of the managers are thinking that cost minimizing is a process of cost cutting. But the
reality is totally different. Cost minimizing is some kind of a value management approach. It is
all about how to accomplish the targets effectively with less amount of expenses.

Cost minimizing can be simply defined as maximizing the efficiency or using the lowest cost to
produce the product or service. It can be mainly categorized as short run cost minimization and
long run cost minimization accordingly.

The proper practical understanding of the firm’s cost structure, a manager can directly address
the key cost which can be reduced without conflicts. Often this less understanding of cost leads
to issues in minimizing cost as it is a process of analyzing data with the relationship of industry
directly. Statistical techniques and practical understanding is critical in reducing cost as
otherwise it would be a difficult task.
Case Study on “A Managerial Application of Cost Functions by Rail Road”

2. Can control chart of the sort described in this case managers to minimize costs? if so, how?

Yes,

The control chart gives a better version of many issues and the decisions that we can make with
them are more effective. As well as it assists managers in reducing waste by allowing them to
evaluate the consistency of a specific process, determine the mean and variability within the
process, and determine the effects to improve the process. Controlling costs will positively
impact financial performance. Therefore, lower costs will be effective to gain higher profit.
Investing in installing an automation system such as labor management, vehicle management
system etc. It will be high costs hence it will negatively impact on financial performance at that
moment, but later on it will reduce the cost.

Managers can easily understand issues that should be corrected by using variations that spike
outside of their control limits, can predict future performance, based on analysis can generate
new ideas for quality improvements are some of the advantages of using control charts

By using control chart managers have been identified how to minimize the cost. According to the
case study they have identified four days out of six days were out of control. The reason was one
of the days was Labor Day. Since it was a holiday, they had to pay a punitive wage as per the
constitution of labor. It was applicable on Sunday as well and they have identified three
circumstances to minimize the cost.

● Cars delivered to other yards, amounted up a significant share of the cars delivered since
such cars are relatively easy to deliver through that cost could be depressed.
● Use more efficient methodologies to handle incoming cars.
● Some of the yard's regular tasks were delegated to another yard.
Case Study on “A Managerial Application of Cost Functions by Rail Road”

3. Is equation 1 a short run or long run cost function? Why?

The main difference between short run and the long run is in the short run we can see both fixed
costs and variable cost attributes are involved, but in the long run all the cost factors are
considered as variables.

As per the case study the equation was formulated using the data of 61 days, which is a short
period of time. On the other hand, equation 1 has both fixed cost and variable cost attributes. The
costs of all the inputs to the production process that are fixed or constant in the short run are
referred to as fixed costs. The cost of all the variable inputs to the production process are referred
to as variable input costs. Considering all these factors, we can determine that equation 1 is a
short run cost function.

Figure 1: Fixed Cost and Variable Costs of Equation 1

4. Relationship between cost and switching and delivering cars given below

C= 4914+0.42S+2.44D

Here, two variables are affecting the cost. According to the Marginal cost definition, MC is the
deviation of cost when you produce an additional unit . In a simple way, Marginal cost is the
gradient of the respective cost curve. When considering the marginal cost of switching a car,
delivering car is considered (D=0) because we only want to get the change in cost when
increasing the S by one more unit. Change in S is given by its gradient, Therefore Marginal cost
of switching a car is 0.42.

5. As mentioned in the case study, average relationship between cost and

output is,

6. C = 4914 + 0.42S + 2.44D

Marginal cost can be defined as increases in total cost when output is increased by one unit. Here
in this case study there are two factors affecting the cost, that are number of cuts switching and
Case Study on “A Managerial Application of Cost Functions by Rail Road”

number of cars delivering. But when calculating marginal cost of one variable, other variables
Case Study on “A Managerial Application of Cost Functions by Rail Road”

should be taken as fixed. Therefore, when calculating MC of delivering a car, the number of
switching cuts should be as remaining.
Here marginal cost of delivering a car is deviation of cost by increasing one quantity of delivering
car. Therefore, the Marginal Cost is dC/dS = 2.44.

7. Does the average cost per cut switch exceed the marginal cost of switching a cut?

In the short-run cost function, we need to consider only one variable at a time. Therefore, here we
only considered variable cost of cut-switched while keeping other factors constant.
Therefore, assuming,
delivery a car D = 0 at ith day
no of cut-switched = no of switched a car = out put

Based on cost functional relationship given in the equation C= 4914+0.42S+2.44D

C = 4914+0.42S+2.44D
C = 4914+0.42S [where D =0]

If we consider number of cut-switched (S) on ith day = 1 unit’

TVC = 0.46 S
TVC = 0.46 X 1
TVC = 0.46
So, Average variable cost of cut-switched AVC is calculated by,
AVC = TVC/Q where Q = Output
AVC = 0.46/1 Q = 1 Unit; TVC = 0.46
AVC = 0.46

In this case, AVC = MC (Marginal cost of cut-switched was calculated in question no 04)
This is called break-even point. At this point, the total production cost is equal to the total expenses.
Therefore, no net loss or gain in the process.

8. In what ways can these estimates of marginal and average cost be useful to railroad
managers? Explain

As explained in Q-5 the MC is the cost of producing one more unit of a good. Marginal cost
includes all of the costs that vary with the level of production. The purpose of analyzing marginal
cost is to determine at what point an organization can achieve economies of scale to optimize
production and overall operations. Hence MC and AC are important for railroad managers in
making decision as it shows the costs at a very definite point in time. When marginal cost is less
than average cost, average cost falls and when marginal cost is greater than average cost, average
cost rises.
Refers to the railroad industry, managers can decide on the price by identifying the normal and
abnormal profits. Further managers can fix the freight charges for delivery services using MC &
AC principles. Above estimation gives an indication of firm’s financial strength whether firm is
Case Study on “A Managerial Application of Cost Functions by Rail Road”

earning enough to cover total variable cost or not. Hence estimation on above MC & AC are
really useful for railroad managers to make future decision on their growth and the sustainability.
Firms can use average total cost to assess productivity at different outputs or while modifying
different production parameters. The marginal cost curve of a company also serves because its
supply curve.

1. Workplace (Labor) choices

2. Identifying fixed expenses

3. Keeping track of variable expenses

4. Business-improvement marketing decisions

5. The average projected income

6. The minimum quantity that must be produced in order to break even.

7. Roper's whole business process analysis

Managers may determine breakeven points that utilize the projections to calculate foregoing by
generating and charting these curves, which should be incredibly important for the long
performance of the company.