In a moderate market, which option yields the highest payoff?

• A. Large Plant
• B. Subcontracting
• C. Small Plant
• D. None of the above

Answer: (C)

In this situation, capacity decisions hinge on matching what you can produce with what the market will bear. A moderate market means there’s enough demand to use some capacity, but not so much that a very large facility will be fully utilized. Fixed costs matter a lot here: a large plant requires a hefty upfront investment, and if demand isn’t high enough, those fixed costs get spread over a smaller output, lowering payoff.

A small plant keeps fixed costs low while still providing enough capacity to meet the expected moderate demand. It avoids the risk of underutilization that comes with a large plant, and it isn’t faced with the higher per-unit costs that can accompany a subcontracting setup if the supplier prices are unfavorably high. In other words, you gain the flexibility and lower risk of a smaller operation while still capturing the needed volume, which tends to maximize payoff in a moderate market.

Subcontracting can be flexible, but it often comes with higher variable costs or less control over quality and timing, which can erode payoff in a market that isn’t booming. None of the above would only be right if neither capacity strategy made sense, which isn’t the case here.