A managerial response to falling demand

A sharp fall in demand for goods can have a devastating effect on corporate performance. Possible managerial responses may include: redesign of the product, opening new markets, product diversification, financial restructuring to reduce debt, take-overs or mergers to reduce overall production capacity, alliances to share expenditure (for example, in R&D and distribution), and so on. All these measures are largely of a long-term nature. As for the short term, three main strategies need to be considered (singly or in combination): (1) reduce price to stimulate demand; (2) increase advertising and promotion expenditure, again to stimulate demand; (3) reduce unit cost to improve the competitiveness of the product and thereby ward off a fall in profitability. This paper is concerned with the third option, assuming that price and promotion expenditures remain unchanged. The paper explores how actions taken to reduce fixed and variable costs can affect profit, profit margins and unit cost, and proceeds to explore the degree of cost reductions that are necessary to maintain the original profit level that pertained prior to the fall in demand. The use of incremental calculus allows the derivation of general results that should be of great interest to managers in times of economic recession.