Question

Hyundai Heavy Industries Co. is one of Korea’s largest industrial producers. According to an article in BusinessWeek Online, the company is not only the world’s largest shipbuilder but also manufactures other industrial goods ranging from construction equipment and marine engines to building power plants and oil refineries worldwide. Despite being a major industrial force in Korea, several of the company’s divisions are unprofitable, or “bleeding red ink” in the words of the article. Indeed, last year the power plant and oil refineries building division recorded a $105 million loss, or 19 percent of its sales. Hyundai Heavy Industries recently hired a new CEO who is charged with the mission of bringing the un-profitable divisions back to profitability. According to BusinessWeek, Hyundai’s profit-driven CEO has provided division heads with the following ultimatum: “... hive off money-losing businesses and deliver profits within a year—or else resign.” Suppose you are the head of the marine engine division and that it has been unprofitable for 7 of the last 10 years. While you build and sell in the competitive marine engines industry, your primary customer is Hyundai’s profitable ship-building division. This tight relationship is due, in large part, to the technical specifications of building ships around engines. Suppose that in your end-of-year report to the CEO you must disclose that while your division reduced costs by 10 percent, it still remains unprofitable. Make an argument to the CEO explaining why your division should not be shut down. What conditions must hold for your argument to withstand the CEO’s criticism?

Short answer

Taking into account all of the criteria, the marine engine should continue to operate in order to avoid economic loss.

Step-by-step solution

Given Information

• Given that the marine engine division has been losing money for seven out of ten years, despite a ten dollar cost decrease, the division is still losing money. As a result of the losses, the division was obliged to shut down operations. Given that the division's principal customer is Hyundai's profitable shipbuilding division, it is my obligation as division head to defend and explain why our division should not be closed.

Explanation

• In a multiproduct cost function, cost complementarities occur. When the marginal cost of producing one output falls as the production of another product rises, precisely when a product's output rises, the marginal cost of producing the other output falls as well.
• Because they buy marine engines from our marine engine division, there are cost complementarities between Hyundai Heavy Industries Co.'s shipbuilding and marine engine divisions in this scenario. Because they must complement each other, if the marine engine division ceases operations, the shipbuilding division of Hyundai Heavy Industries Co. is more likely to become unprofitable.
• Since the Marine Engine has lowered our cost by 10%, we now have a lower pricing for marine engines than those available outside. So, if we cease operations, Hyundai Heavy Industries Co.'s shipbuilding division will have to find a new supplier, which may be unprofitable.
• As a result, taking into account all of the criteria, the marine engine should continue to operate in order to avoid economic loss.