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Over-land’s management is considering the proposal from FHP. There are many issues involving strategy, cost, risk, and capacity. Prepare a recommendation to management. Use the following questions to guide your analysis.
1. Assume Over-land could service the contract with existing equipment. Use Exhibit 1 to identify the relevant costs concerning the acceptance of FHP’s request to add two additional loads per week. Which costs are not relevant? Why?
2. Calculate the contribution per mile and total annual contribution associated with accepting FHP’s proposal. What do you recommend? (Use 52 weeks per year in your calculations.)
3. Consider the strategic implications (including risks) associated with expanding (or choosing not to expand) operations to meet the demands of FHP. Analyze this question from a conceptual point of view. Calculations are not necessary.
4. After a closer examination of capacity, management believes an additional rig is required to service the FHP account. Assume Over-land’s management chooses to invest in one additional truck and trailer that can serve the needs of FHP (at least initially). Assume the annual incremental fixed costs associated with acquiring the additional equipment is $50,000. Further, FHP would agree to pay $2.20 per mile (total including FSC and miscellaneous) if Over-land would sign a five-year contract. What is the annual number of miles required for Over-land to break even, assuming the company adds one truck and trailer? What is the expected annual increase in profitability from the FHP contract? (Use 52 weeks per year in your calculations.)
5. Over-land has business relationships with independent contractors, though Alan is reluctant to use them. Another possibility for expanding capacity is to outsource the miles requested by FHP. One of Over-land’s most reliable independent contractors has quoted a rate of $1.65 per mile. As with question 4, assume FHP would agree to pay $2.20 per mile if Over-land would sign a five-year contract. Further, assume Over-land would incur incremental fixed costs of $20,000 annually. These costs would include insurance, rental trailers, certain permits, salaries and benefits of garage maintenance, and office salaries such as billing. How many annual miles are required for Overland to break even if the miles are outsourced? What is the expected annual increase in profitability from the FHP contract? What are your conclusions?
6 a. Why might Over-land use an independent operator if the variable cost per mile is higher than if the company had purchased a rig and hired a driver? b. At what point would management be indifferent between the scenarios illustrated in questions 4 and 5? Based on your analysis, would you recommend adding capacity by purchasing an additional rig or by utilizing the services of an independent contractor? Why?
7. The case references J. B. Hunt and Landstar as two publicly traded companies that have two very different cost structures. This is true because the companies practice two different philosophies for using (or not using) owner operators (e.g., independent contractors). Speculate about the company that may produce higher profits in periods of high economic demand. Why? Speculate about the company that may have a less risky cost structure in poor economic times. Why?
8. All organizations have the potential to perform work, which is determined by the types of resources and the organization’s capacity. Effective use of resources can be critical to a firm in any competitive market. In their efforts to efficiently use capacity, managers may ask questions such as: What portion of the available capacity is in use? Of the capacity in use, what portion is used productively? How can we increase the productive use of capacity? Why is a portion of available capacity not in use? Can we eliminate unused capacity? Over-land’s management is no different. In fact, management is not exactly clear about how to view capacity. Discuss the challenges that Over-land’s management faces with defining and managing capacity. Consider various definitions of capacity, such as theoretical, practical, normal, and actual capacity. Based on the facts presented in the case, prepare an estimate of capacity for Over-land (assuming one driver per rig without slip seating or team driving).