Investing in additional capital and labor is a long-term strategic decision managers use in anticipation of or response to increasing demand. Capital investments include things like buying new production machinery, buildings or vehicles. Labor investments include taking on additional employees either by expanding current departments or opening new facilities. Managers take a number of factors into account when weighing the decision of whether to invest in new capital or labor to increase the chances the investment will pay off.
Return on Investment (ROI)
Return on investment is a basic metric investors use to judge the past performance of investments or to predict the expected performance of potential investments. The same principle that applies to investors buying securities also applies to businesses making long-term purchase- or expense-related decisions. Consider a manufacturer deciding whether to invest in automated production technology, for example. The manufacturer would likely compare the expected increase in output and correlating increase in sales revenue to the cost of purchasing and installing the machinery. If the expected ROI works out to be large enough, the decision may be a good one.
Changes in demand can be short term or long term. Managers must consider whether a current uptick in demand is a signal of a long-term shift, or if it is a result of a temporary factor. If demand spikes in the short term, it can be wiser to boost production using temporary measures, such as taking on seasonal workers, rather than investing in additional full-time staff or larger production capacity. If a trend promises to show strength over an extended period, on the other hand, it can be more cost effective to invest in your own additional labor and capital equipment than to rely on temporary measures.
The total costs of making different investments can vary over time. The current cost structure of a specific investment is an important factor in determining when to make capital or labor investments. Managers should consider whether they will have to take on debt to finance the investments, for example, and whether they may be able to wait a bit longer and use cash instead. If a company has to use debt, managers should consider what interest rates are currently available and how rates are likely to change in the near future. In a labor market where supply exceeds demand, companies may have to pay higher salaries and offer more valuable benefits than they would have in a labor market with high unemployment.
A fundamental question to ask yourself before investing in additional capital and labor is "can I accomplish my goals without additional investment?" It may be possible to accomplish goals using creativity and innovation rather than investment. Redesigning your production processes may increase output enough to avoid hiring new workers, for example. Outsourcing certain non-vital business functions, as another example, can help you to avoid investing in new machinery.
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