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1.6. Growth and Evolution: Economies and Diseconomies of Scale
1.6. Growth and Evolution: Economies and Diseconomies of Scale
Scale of operations/business
Maximum output that can be achieved using available resources
Scale can only be increased in the long term by employing more of all
inputs
Producing more =/ increasing scale of production
Increase scale of operations attains economies of scale
Economies of scale
Increase in efficiency of production as the number of output increases
Average cost per unit decreases through increased production
Fixed costs are spread over an increased number of output
Cost per unit = (total variable costs + total fixed cost) ÷ units produced
Importance: customer enjoy lower prices due to the lower costs which
in turn increases market share or business could choose to maintain
its current price for its product and accept higher profit margins
Types of economies of scale:
Internal – achieved by the organization itself
Purchasing (bulk-buying) economies
Wholesale discounts
Technical economies
Investing in technology to reduce costs
Financial economies
Easier for large companies to receive loans from banks
Marketing economies
More efficient to advertise a large number of products
Managerial economies
Larger firms are able to hire specialists who help improve
efficiency
External
Improved infrastructure (e.g. transportation)
Advances in the industrial efficiency due to better training,
innovations in processes/machinery, etc.
Growth of other industries that support the organization
Diseconomies of scale
Economies of scale have peaks, if this point is passed, diseconomies
of scale are experienced
Can occur when a company or even the whole industry becomes too
big and unit costs begin to increase rather than decrease
Possible due to:
Communication problems leading to poor coordination
Overworked machinery and laborers
Alienation of workforce and slower decision-making (for larger
businesses)
Diminishing marginal returns
Decrease in the marginal (per-unit) output of a production process
as the amount of a single factor of production is increased, while
the amounts of all other factors of production stay constant
Internal/organic growth
Occurs when businesses grow using its own resources to increase
the scale of its operations and sales revenue
Methods used to achieve internal growth:
Change of pricing strategies
Increase advertising and promotions
Offer flexible financing schemes
Improve and innovate the product or service
Sell in different locations
Increase capital expenditure on production and technologies
Train and develop staff
External/inorganic growth
Occurs through dealings with outside organizations
Vertical integration
The main business takes part in the primary, secondary, and
tertiary aspect of business
Horizontal/lateral integration
Businesses unify under the same industry
Between firms who have the same operations, but do not
necessarily compete with one another
e.g. Ford bought Jaguar, Ford is low to mid class while Jaguar is
high class. They don’t compete and when they merge they now
cater to a bigger market
Globalization