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Cost Benefits and Scale of Operations

Cost Benefits and Scale of Operations

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Published by ClassOf1.com
Firms expand capacity by increasing the scale of production to avoid turning business away and to increase market share, but they also benefit from the advantages of large-scale production – these are called economies of scale.
Firms expand capacity by increasing the scale of production to avoid turning business away and to increase market share, but they also benefit from the advantages of large-scale production – these are called economies of scale.

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Published by: ClassOf1.com on Nov 27, 2013
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11/27/2013

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Operations Management
 
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The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.
Subject: Operations Management
 
Cost enefits and Scale of Operations
There are risks and costs involved in increasing the scale of production
 purchasing land,  buildings, equipment, employing more staff
 and the capital used for this will always have alternative uses. Firms expand capacity by increasing the scale of production to avoid turning  business away and to increase market share, but they also benefit from the advantages of large-scale production
 
these are called economies of scale. Economies of scale are reductions in a firm’s
unit (average) costs of production that result from an increase in the scale of operations. These cost benefits can be so substantial in some industries that smaller firms will be unlikely to survive due to lack of competitiveness, such as in oil refining or soft drink production. The cost benefits arise for five main reasons.
 
These economies are often known as bulk-buying economies. Suppliers often offer substantial discounts for large orders. This is because it is cheaper for them to process and deliver one large order rather than several smaller ones.
 
There are two main sources of technical economies. Large firms are more likely to be able to  justify the cost of flow production lines. If these are worked at a high capacity level, then they offer lower unit costs than other production methods. The latest and most advanced technical equipment
 such as computer systems
 is often expensive and can usually only  be afforded by big firms. Such expense can only be justified by larger firms with high output levels
 so that average fixed costs can be reduced.
 
Large organizations have two cost advantages when it comes to raising finance. First, banks often show preference for lending to a big business with a proven track record and a diversified range of products. Interest rates charged to these firms are often lower than the rate charged to small, especially newly formed, businesses. Secondly, raising finance by
‘going public’ or by further public issues of shares for existing public limited companies is
 
 *
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.
Subject: Operations Management
 
 very expensive. Therefore, the average cost of raising the finance will be lower for larger
firms selling many millions of dollars’ worth of shares.
 
 
Marketing costs obviously rise with the size of a business, but not at the same rate. Even a small firm will need a sales force to cover the whole of the sales area. It may employ an advertising agency to design adverts and arrange a promotional campaign. These costs can  be spread over a higher level of sales for a big firm and this offers a substantial economy of scale.
 
Small firms often employ general managers who have a range of management functions to perform. As a firm expands, it should be able to afford to attract specialist functional managers who should operate more efficiently than general managers, helping to reduce average costs.

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