OPERATE OR TEMPORARY SHUTDOWN

Operate or Temporarily Shutdown

Differential cost analysis is also used when a business is confronted with the possibility of a temporary shutdown. This type of analysis has to determine whether in the short-run a firm is better off operating than not operating. As long as the product sold recover their variable costs and make a contribution towards the recovery of fixed costs, it may be preferable to operate and not to shutdown. Also management should consider the investment in the training of its employees which would be lost in the event of temporary shutdown. Recruiting and training new workers would add to present costs. Another factor is the loss of established markets. Also a temporary shutdown does not eliminate all costs. Depreciation, taxes, interest, and insurance costs are incurred during shutdown also. The other benefits which should be considered are the following: avoiding operating losses, savings in maintenance and repair costs, savings in indirect labour costs and savings in fixed costs.

Even if sales do not recover the variable cost and the portion of fixed cost that is avoidable, the firm may still be better off operating than shutting down the facility. Closing a facility and subsequently reopening it is a costly process. The shutdown may necessitate the incurrence of maintenance procedures in order to preserve machinery and buildings during periods of inactivity (e.g. rust inhibitors, dust covers, security equipment, etc). The shutdown also may require the incurrence of legal expenditures and employee maintenance pay. During the shutdown period, some employees will probably be lost (i.e., they may not wait until the facility is reopened to go back to work), in which case the investment in the training of those employees will be lost. The morale of other employees, as well as company goodwill, may be adversely affected, and the recruiting and training of replacement workers that must be incurred when the facility is later reopened may add to costs. Although difficult to quantify, the loss of established market share is also a factor to be considered. When a company leaves a market for a while, its customers tend to forget about the company’s product. As a consequence, re-entering the market at a later time will probably require re-educating consumers about the company’s product. These shutdown costs must be weighed against losses from continued operations.