Economies and Diseconomies of Scale
Learning Objectives
Understand internal and external economies of scale
Understand diseconomies of scale
Understand the limits of growth
Subject Vocabulary
Introduction
Setting up a business and ensuring its survival is challenging. Once established, owners often aim for growth by increasing the scale of operations, which can lead to reduced costs.
Economies of Scale
Definition:
Financial advantages gained from producing in large quantities leading to falling average costs. Larger firms typically produce goods more cheaply than smaller firms.
Average cost decreases as output increases up to an optimal level. For example, average costs drop from $25/unit at 20,000 units to $10/unit at 70,000 units before rising again due to diseconomies of scale beyond that point.
Internal Economies of Scale
Definition: Cost benefits that a single firm experiences when it grows.
Types:
Purchasing Economies: Large purchases lead to discounts on ingredients.
Managerial Economies: Larger firms can employ specialists in management, increasing efficiency.
Marketing Economies: Marketing costs are fixed, spreading over larger output reduces average cost per unit.
Technical Economies: Larger firms can invest in advanced machinery.
Financial Economies: Larger firms typically secure lower interest rates and can issue shares while smaller firms can't.
Risk-bearing Economies: Larger firms can diversify their product range and markets, lowering business risk.
External Economies of Scale
Definition: Cost advantages that accrue to all firms in an industry as the industry grows.
Examples:
Skilled labor pools in industry-dense regions.
Infrastructure development benefits all industry players.
Ancillary services such as suppliers setting up nearby.
Cooperative initiatives between firms in the same industry.
Diseconomies of Scale
Definition: Rising average costs experienced when a firm grows too large, leading to inefficiencies.
Factors Contributing to Diseconomies:
Bureaucracy: Increased layers of management can slow down decision-making.
Labor Relations: As firms grow, worker-manager relations can suffer, leading to demotivation.
Control and Coordination: Managing a very large workforce and operations becomes challenging.
Case Study: Volkswagen Scandal
VW was accused of manipulating emissions data. Due to its size, the organization became prone to bureaucratic inefficiencies.
Limits to Growth
Lack of Finance: Businesses may wish to grow but are unable due to lack of investment.
Market Size: Some markets may be too small to support large companies.
Management Skill Deficits: Owners may lack the expertise or willingness to manage larger operations effectively.
Lack of Motivation: Some owners are satisfied with current operations and do not seek growth.
Large vs Small Businesses: Small businesses cannot benefit from economies of scale and may face challenges to grow.
Production and Productivity - Different Methods
Job Production: Producing one unit at a time, with high craftsmanship but lower efficiency. Ideal for bespoke or custom items.
Batch Production: Producing a specific number of identical products before switching to another type. It strikes a balance between efficiency and flexibility.
Flow Production: Continuous production of standardized goods, reducing unit costs but requiring a high initial investment in machinery.
Lean Production
Focuses on minimizing waste while maximizing productivity. Methods include Just-In-Time (JIT) and Kaizen.
Quality Management
Importance of Quality
Quality impacts customer satisfaction, safety, and brand reputation. Poor quality can lead to costly recalls.
Quality Control vs Assurance
Traditional QA methods involve completing checks after production. TQM incorporates a culture of quality throughout all processes.
Conclusion
Both economies of scale and quality management are crucial for business growth and competitive advantage. A careful balance must be found to harness the benefits of scale while maintaining quality.
Knowt
Note
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