Question

Analyze about this Diversification- Auto Rental

During the last meeting of your management team, the planning officer presented a proposal for diversifying. It was to acquire a rental car agency at the smallest city you are currently serving. While there is a car rental agency located downtown at a service station and a locally owned taxi service serves the airport, there is no car rental agency serving the airport. Although the total passengers boarded daily there is modest, quite a few people do inquire about the availability of rental cars. Your local station manager is very excited about the prospects of building up a reasonable rental business there and wants the opportunity to try it. A firm that has been very successful at franchising such operations is interested in supporting your efforts. This firm would sublease autos to you as needed and provide insurance coverage. (Insurance is difficult to obtain for small operations such as this.) The firm would guarantee the availability of enough autos to handle 90% of the business 90% of the time; in other words, it is not profitable to keep an expensive inventory for the few times of high demand. The start-up costs would be $200,000 allocated over eight quarters. This would pay for the cost of the initial franchise fee, advertising, paving of a small storage lot, and rebuilding your ticket counter to include space for the retail business. Extensive cost and revenue studies have been made. They indicate a high probability of success but conflicting data on how successful. Starting losses of from $3,000 to $10,000 per quarter could be expected the first one or two quarters. After that, there is a 10% probability of just breaking even, a 60% probability of making $60,000 per quarter, and 30% probability of making between $60,000 and $100,000 per quarter. The director of marketing focused on the crux of the matter as she noted, “After making a cost benefit analysis of both propositions, it will boil down to the question, ‘What business are we in, or what businesses should we be in?

It is an important strategic question. Personally, I think we should be in the transportation business and this acquisition would fit that mission.” The financial vice president responded with a worried look, “Yes, but it will take financial resources away from our passenger airline business. Are we strong enough to take on something new?” Another staff member responded, “A competitor may choose to pick up the franchise if we don't. Perhaps we should consider it as a defensive strategy and not necessarily one in which we plan to make a profit.” The president added, “Does this fit with our strategic plans?”

1. Begin the auto rental business.

2. Do not begin the auto rental business.

Which would be the best answer and why?

Answer 1

Going or not to enter a certain business is mainly driven by the probability of making a profit and the time taken by the company to recover its investment. These are the two main important factors that are to be considered before making the entry decision in any industry. If we look at the given case, it is stated that there is a 10% probability of just breaking even, a 60% probability of making $60,000 per quarter, and a 30% probability of making between $60,000 and $100,000 per quarter. So if we look at this stats, there is almost a 90% probability that the company can earn a profit from $60,000 and $100,000 per quarter. This indicates that the chances of the company to be successful in the auto rental industry are quite high.

Thus I would recommend the company to enter in the auto rental industry