3.1.4.3 Economies of Scale

Economies of scale

Benefits enjoyed by a business as it increases the scale of its operations leading to a fall in unit cost.

Unit cost

Cost of producing one unit of output.

Economies of scale

Where the average or unit cost of production falls as the scale of production rises. This means that the more units that a business produces, the lower the cost of producing each one will become, this is because the fixed costs such as rent or marketing are spread over more units.

Types of economies of scale

Technical, Managerial, Financial, Risk-bearing, Purchasing.

Managerial

A larger firm can afford to employ the best people in their fields. These experts can help both to increase revenue and reduce costs.

Purchasing

A firm can gain a discounted price from a supplier as they are buying in larger quantities.

Financial

Larger firms tend to be less risky. They have already established a customer base and are likely to have assets that can be sold to pay off debt. Therefore, they can access cheaper sources of finance as they are less of a risk.

Technical

A firm can invest in a new product development or technology to make their production processes more efficient.

Risk-bearing

Large firms can spread their risk. They can afford to make a loss in one market because they are big enough to operate in other,more profitable markets.

Internal and external growth

Many businesses have an objective of growth in order to achieve economies of scale. This can be achieved through internal growth or external growth.

Internal growth

When a business expands from within. Ex = opening new stores of launching new products.

External growth

When a business grows by joining with other businesses. Ex = buying out a competitor.

Approaches to internal growth

Franchising, Opening new stores, E-commerce, Outsourcing.

Franchising

A franchise is when one business gives another person or business the right to trade using its name and to sell its products or provide its services. The franchisee normally pays a licence fee and a percentage of profit to the franchisor.

What is an advantage of franchising related to risk?

Lower risk option as others are taking on some of the responsibility.

How does franchising affect growth speed?

Can grow more quickly.

What is a marketing advantage of franchising?

Can use national advertising campaigns.

What type of knowledge can franchises provide?

Franchises may have specialist knowledge of other regions or countries.

What is a disadvantage of franchising related to profit?

Franchisee will keep a share of the profit.

What is a disadvantage of franchising regarding standards?

Reliant on others to maintain standards.

What is a potential risk to a franchisor's brand?

Potential damage to brand reputation.

What is a disadvantage of franchising related to setup?

Complex procedures to set up as a franchisor.

Opening new stores

Increasing the no. of physical stores. Making it more convenient for customers.

What is e-commerce?

The use of online sales to develop new channels of distribution.

What is one advantage of e-commerce for businesses?

It allows a business to trade 24/7.

How does e-commerce affect a business's geographical presence?

It allows for a larger geographical presence.

What social aspect does e-commerce help businesses keep up with?

Social trends.

What is outsourcing?

Using a 3rd party to carry out some functions on behalf of the business.

What is an example of outsourcing?

Increasing the amount of goods produced by having another factory manufacture on your behalf.

Which countries are commonly associated with outsourcing?

China and Mexico.

External growth can happen in 2 ways

Merger & takeover

Merger

Where 2 businesses agree to become integrated to form one business under joint ownership.

Takeover

Where one business buys another. The manager of the dominant business will be in control.

Advantages of internal growth

Relatively low risk. It builds on the business' own strengths. Can be financed through the business' internal funds such as retained profit.

Advantages of external growth

Can be achieved quickly. Expertise between businesses can be shared. Business has access to customers of both businesses. It can allow a business to establish itself in a new market quickly.

Diseconomies of scale

When a business becomes inefficient because of growth. Leads to a rise in unit costs.

Diseconomies of scale include

Communication, Coordination, Reduced staff motivation.

What is a challenge of communication in large groups?

More people makes it difficult to keep everyone up to date and informed.

What can happen to messages in a large group communication?

Messages may get confused or take long to get to the right people.

How can communication challenges affect supplier relationships?

Relationships with suppliers may become difficult to maintain.

Coordination

Increased number of resources are difficult to coordinate to ensure everything is being used efficiently.

Reduced staff motivation

Reduces productivity. Employees may be absent.