ECON 5003 Module 6 Integrated Economic Recommendation Example

Buy the Silo, Not the Trucks: One Recommendation That Draws Together Market Structure, Pricing, Rivalry, the Rate Cycle and Currency Risk for a Concrete Producer

Student Name

American College of Education

ECON5003: Economics Analysis

Module 6 Assignment

Instructor Name

August 7, 2028

The Recommendation

Bellwether Ready-Mix, the composite producer studied throughout this course, should build a rail-served cement storage silo at its eastern plant, a project priced near $1.1 million, and sign a ten-year agreement to buy about half of its cement from a cement plant 180 miles away. Today, the integrated rival that leads the local concrete market supplies about 70 percent of Bellwether's cement. The recommendation would reduce that to about 35 percent. It should be funded partly by deferring the $1.2 million truck purchase that Module 4 already recommended postponing. Every analysis this term found the same weakness from a different angle: Bellwether buys its most important input from its most important competitor.

What Each Analysis Contributes

Market structure. Module 1 found a highly concentrated local market, with a Herfindahl-Hirschman Index near 3,000, in which the integrated rival holds the largest share and controls cement and aggregates. It identified the cement relationship as the feature that most limits Bellwether's freedom to compete. Syverson (2004) found that competitive pressure in concrete markets works through entry, exit and productivity; a producer that cannot control a fifth or more of its variable cost is exposed to that pressure without the tools to respond. Pricing. Module 2 showed that cement is the largest single element of Bellwether's variable cost, about $45 of $118 per yard, and that the rival's planned $10-a-ton increase would erase part of any price gain.

Rivalry. Module 3 modeled the pricing game and found that the rival's best response to a Bellwether price increase is to hold its price, partly because every customer it captures also raises the utilization of its cement plant. Reducing Bellwether's cement purchases from the rival lowers the rival's stake in Bellwether's volume only slightly, but it removes the rival's ability to squeeze Bellwether's costs, and in a repeated game, as Axelrod and Hamilton (1981) showed, a player that can respond is more likely to meet cooperation than one that cannot. The rate cycle. Module 4 forecast a 10 percent fall in volume and recommended conserving cash. The silo is a better use of scarce capital than new trucks, which would add capacity the company does not need in a downturn, while the silo reduces a cost that persists in every phase of the cycle. Currency and trade. Module 5 recommended covering the euro exposure on the new batch plant. The domestic cement agreement is priced in dollars and carries no currency risk, unlike imported cement, which was considered and rejected for that reason.

Costs and Returns

Bellwether uses about 112,800 tons of cement a year across all its concrete. Moving about half, 56,400 tons, to the distant plant would cost about $5 a ton more than the rival's current delivered price, because of rail freight, but about $5 a ton less than the rival's price after its announced $10 increase. At the new price, the saving is about $282,000 a year; against the rival's current price, the new source would cost about $282,000 more. The honest range for the annual effect is therefore from a cost of that amount, if the rival rescinds its increase, to a saving of that amount, if the increase holds. The silo's cost of $1.1 million would be recovered in about four years in the second case and not at all on cost grounds in the first.

The decision should not rest on cost savings alone. Its main return is strategic: a supplier that knows its customer has an alternative prices differently from one that knows it does not. The rival's announced increase is itself evidence of how its pricing behaves when Bellwether has no alternative, and a second source makes future increases of that size harder to impose.

Funding It in a Downturn

Module 4's forecast makes capital scarce, which could argue for waiting. Froot et al. (1993), however, argued that firms create value by ensuring they have internal funds for valuable investments when those opportunities arise. The opportunity here has a window: the distant cement plant has offered a ten-year price schedule because it has spare capacity in a slowing market, an offer less likely to be available in a boom. Deferring the truck purchase frees $1.2 million, enough to fund the silo without increasing borrowing on the floating-rate credit line. The company would enter the downturn with slightly less fleet capacity, which Module 4 showed it does not need, and a permanently lower dependence on its rival.

Alternatives Considered

The owners weighed three other paths. Doing nothing and accepting the rival's cement increase would cost about $282,000 a year more than the recommended mix if the increase holds, and would leave the company exactly as exposed in the next round. Another was to import cement through a coastal terminal 140 miles away. Imported cement was priced competitively, but the supplier would invoice in euros, adding a currency exposure of the kind Module 5 worked to reduce, and deliveries from the terminal depend on ship schedules that are harder to predict than rail. The last was to merge with or acquire one of the two independent producers, which would add volume and bargaining weight in cement purchasing but would raise concentration in an already highly concentrated market, invite antitrust review and require far more capital than the company can commit during the downturn Module 4 forecast.

The silo and supply agreement are the smallest step that changes the company's position. They require modest capital, create no new currency risk, raise no competition concern and can be reversed in part by shifting volume back to the rival if the distant plant fails to perform.

Risks

The recommendation carries three risks. First, the rival could respond by cutting its cement price to Bellwether below the distant plant's, to keep the volume; that outcome would still benefit Bellwether and would confirm that the second source changed the rival's pricing. Second, rail service could be unreliable, so the silo should hold at least ten days of cement, and Bellwether should keep buying some cement from the rival to maintain the relationship and a backup supply. Third, the ten-year commitment could prove costly if cement prices fall generally; the agreement should include a price review every three years tied to a published cement price index.

What the Owners Should Do in the Next Ninety Days

Within ninety days, the owners should take four steps: sign a term sheet with the distant cement plant with the three-year price review included; obtain rail access and zoning confirmation for the eastern plant site; cancel or defer the truck order and redirect the funds; and inform the rival's cement sales office, in a purchasing conversation that excludes any discussion of concrete prices, that Bellwether will be reducing its purchases from the second half of next year. The silo can be operating within nine months. None of the other decisions from this term changes: Bellwether should still follow rather than lead price increases, tighten contractor credit and hedge its euro payment. The silo is the one decision that improves its position in all of them.

References

Axelrod, R., & Hamilton, W. D. (1981). The evolution of cooperation. Science, 211(4489), 1390-1396. https://doi.org/10.1126/science.7466396

Froot, K. A., Scharfstein, D. S., & Stein, J. C. (1993). Risk management: Coordinating corporate investment and financing policies. The Journal of Finance, 48(5), 1629-1658. https://doi.org/10.1111/j.1540-6261.1993.tb05123.x

Syverson, C. (2004). Market structure and productivity: A concrete example. Journal of Political Economy, 112(6), 1181-1222. https://doi.org/10.1086/424743