BUS 540 Module 1 Economics and Decisions Example

Two Trucks, One New Contract and the Loads We Would Turn Away: Economic Reasoning for a Trucking Company's Route Decision

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MBA Program, Aspen University

BUS 540: Managerial Economics

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Month Day, Year

Two Trucks, One New Contract and the Loads We Would Turn Away: Economic Reasoning for a Trucking Company's Route Decision

Hawkeye Freight, a composite trucking company in Des Moines, Iowa, operates 28 trucks hauling refrigerated and dry freight across the Midwest. Most of its trucks work on contracts with regular shippers, but six take loads from the spot market, where shippers post loads and carriers bid daily. A regional grocery distributor has offered Hawkeye a one-year contract for a dedicated route: two trucks, five days a week, between its warehouse and 40 stores, for $9,400 a week. The two trucks would have to come from the spot-market group. The owners' first reaction was to accept, since a steady contract sounds safer than daily bidding. This paper applies economic reasoning to the decision.

Scarcity and Opportunity Cost

Every truck-hour Hawkeye sells is a truck-hour it cannot sell to someone else; that is scarcity in its plainest form. Hawkeye's two trucks and their drivers can haul the grocery route or spot-market loads, not both. The opportunity cost of the grocery contract is therefore what those trucks would earn in their best alternative use (Baye & Prince, 2022). Over the past six months, the two spot-market trucks have averaged $10,600 a week in revenue. That figure, not zero, is the starting point for evaluating the offer.

Why Opportunity Costs Are Easy to Miss

Frederick et al. (2009) found in a series of experiments that people often neglect opportunity costs when making purchase decisions. Simply reminding participants that money not spent could be used for other things changed their choices, suggesting that alternatives do not come to mind unless prompted. Managers are vulnerable to the same bias. Hawkeye's owners compared the contract with nothing, a steady $9,400, rather than with what the trucks already earn.

Marginal Analysis

The right comparison is between the additional revenue and additional cost of each use of the trucks over a typical week. Fixed costs that do not change, such as the dispatch office and insurance on the trucks, are excluded because they are the same either way.

The grocery route brings in $1,200 less revenue each week but costs $1,940 less to run, because the trucks drive fewer miles, return empty less often and need no load board or broker time. Its net contribution is $740 a week higher, about $38,500 over a year.

Reading the Table

Three lines explain most of the difference. Fuel is lower on the grocery route because the trucks run about 1,900 miles a week instead of 2,700, most of them loaded; spot loads often require deadhead miles to reach the next pickup. Driver pay is lower because the route is paid by the day rather than by the mile, and the drivers prefer it because they sleep at home. Load board and broker costs disappear because the route needs no daily bidding. Revenue falls by $1,200, but each of these savings is a cost the company would avoid only by taking the contract, which is the essence of a marginal comparison.

The Value of Lower Risk

Spot-market revenue also varies. Over the past six months, weekly revenue for the two trucks ranged from $7,800 to $13,200, while the contract offers a fixed price. Lower variability has value to a company with fixed payments on its trucks and a payroll to meet, even though it does not appear in the averages above.

Setting Aside Sunk Costs

During discussion, one owner pointed out that the two trucks had been bought specifically for spot-market work at a premium price. That purchase is a sunk cost. Whatever the trucks cost, that money left the company years ago and stays gone whichever route the trucks drive, so it cannot tip the comparison.

Thinking at the Margin About Capacity

One further question is whether Hawkeye could take the contract and still serve its spot-market customers by adding trucks. A new truck and driver would add about $3,900 a week in leasing, insurance and wages before carrying any load, against expected spot contribution of about $1,400 per truck. Adding capacity would therefore lose money at current spot rates, which confirms that the real choice is between the two existing uses of the two trucks, not a way to have both.

Why the Firm Exists, and Who Should Drive

Coase (1937) asked why firms exist at all when markets could coordinate production through prices. His answer was that using markets has costs: finding trading partners, negotiating, writing and enforcing contracts. Firms organize activities internally when doing so costs less than buying them through markets. The question applies here because Hawkeye could serve the grocery route by hiring owner-operators, independent drivers with their own trucks, rather than using its own trucks and employees. Owner-operators would cost about $8,600 a week for the route, leaving Hawkeye a margin with no truck use, and freeing its two trucks for the spot market.

But Coase's logic points to the costs of contracting. A dedicated grocery route requires reliable arrival windows, trained drivers who know store procedures and coordination with the distributor's warehouse. Monitoring and replacing owner-operators who miss windows would be costly, and the distributor wants Hawkeye's own drivers. For this route, organizing the work inside the firm is likely cheaper once these costs are counted.

What Could Change the Answer

The recommendation depends on spot rates. Spot-market prices in trucking move with the economy and with capacity; if they rose 15% or more and stayed high, the spot loads would again earn more than the route. Diesel prices also matter, since the spot loads use more fuel. A one-year contract limits the risk of locking in a price that later looks low.

Recommendation

Hawkeye should accept the grocery route, which contributes about $740 more each week than the spot loads and reduces revenue volatility, on two conditions: a fuel surcharge clause that adjusts the price when diesel moves more than 10%, and the option to renegotiate after six months. It should staff the route with its own drivers.

Conclusion

The owners' instinct was right, but for the wrong reason. The contract is not attractive because steady income is better than nothing; it is attractive because, compared with the best alternative use of the trucks, it earns more per week and carries less risk. Opportunity cost, marginal analysis and the exclusion of sunk costs turned an impression into a decision.

References

Baye, M. R., & Prince, J. T. (2022). Managerial economics and business strategy (10th ed.). McGraw Hill.

Coase, R. H. (1937). The nature of the firm. Economica, 4(16), 386-405. https://doi.org/10.1111/j.1468-0335.1937.tb00002.x

Frederick, S., Novemsky, N., Wang, J., Dhar, R., & Nowlis, S. (2009). Opportunity cost neglect. Journal of Consumer Research, 36(4), 553-561. https://doi.org/10.1086/599764