-+THE DEMAND ESTIMATION AND FORECASTING OF

MILCO (PRIVATE) LIMITED

Course: BEC 30325 Managerial Economics

Dr. Sumudu Perera

Year III, Semester II

School of Accounting and Business

The Institute of Chartered Accountants of Sri Lanka

14th July 2018

 TEAM MEMBERS

SAB/BSc/2015/2/A/03 A.B.N Chandrasiri

SAB/BSc/2015/2/A/04 M.S.A. De Silva
SAB/BSc/2015/2/A/07 U.S. Gamage
SAB/BSc/2015/2/A/08 G.K.H. Uthpala
SAB/BSc/2015/2/A/10 D.T. Jayasinghe
SAB/BSc/2015/2/A/11 K. P. Jayawardene
SAB/BSc/2015/2/A/20 I.G.W. Shansana

2
 TABLE OF CONTENT

1. INTRODUCTION
1.1 Company Profile…………….…..………………….........…………….……………...6
1.2 Industrial Overview……………...………..……………..………….…………….…. 8
1.3 Market Leadership………………………………………………...………………….9
2. DEMAND ESTIMATION
2.1 Factor Identification………………………………………………………………....10
2.2 Price Elasticity of Demand………………………………………………….…….....13
2.3 Income Elasticity of Demand……………………………………………………......15
2.4 Regression Analysis………………………………………………………………....16
3. COST ANALYSIS
3.1 Cost Minimization…………………..……………................................................... 26
3.2 Profit Maximization………………………..………………………………...……...27
3.3 Economies of Scales and Diseconomies of scales……………………………...…...29

4. REFERENCES
5. APPENDIX

3
Acknowledgment

We would like to thank everyone who gave us the support to complete this report. First of all,
our sincere gratitude goes to our Managerial Economics lecturer, Dr. Sumudu Perera for
providing this opportunity to do this report and an opportunity to gain practical exposure through
this assignment.
Next we would like to thank the organization, Milco (Private) Limited, for sharing the
information regarding the organization. Furthermore, we would like to thank The Chairman at
Milco, Mr.Eng.Sulfikar Cader for guiding us to get the information which was used to do the
analysis done by our team and the Deputy General Manager (Marketing), Mr. Malcom Auwardt
for the kind support given by him through the process.
This report could not have been completed successfully without the support of many individuals,
we would like to give my sincere appreciation to everyone who gave us the support and
encouragement to do this report. Without you all it would not have been successful. Thank you!

4
Executive Summary

This assignment is carried out as a part of BSc. (Applied Accounting) Degree conducted by CA
Sri Lanka under the Managerial Economics in year III, semester II.
The overall aim of the assignment is to identify how the demand estimation and forecasting is
applied by a company for its products and to describe the way which its application deviates
from theory.

This exercise is to perform a data analysis about how the demand estimation and forecasting is
practiced by Sri Lankan organizations enabling us to understand the practical validity of the
techniques we learn.

Therefore, the group has selected information of products of Milco (Private) Limited and the
topic chosen for the analysis is “Demand estimation and forecasting”. To fulfill the requirements
of the assignment we have selected this company which is a manufacturing company.

5
1.0 INTRODUCTION

1.1 Company Profile

Milco (Private) Limited was established in 1956 as “The National Milk Board” under the
purview of the Ministry of Agriculture. At the initial stage it commenced its operations as a
single factory in Colombo area commissioned under the Colombo plan. It involved in dairy
development, milk collection, milk processing and marketing since 1956 to 1986.

In 1986, the “National Milk Board” was converted into “Milk Industries of Lanka Company
Limited” as a government owned Company. After that this Milk Industries of Lanka Company
Limited’s administration has been taken over by “Kirirya Milk Industries of Lanka (Pvt) Ltd.
Later in 2000, “Kiriya” was owned by the government and 2001 it was named as “Milco (Pvt)
Ltd”, which now stands as a 100% government owned company.

Now it consists a wide range of productions and sales centers all over the country. It has three
milk plants located in Narahenpita, Digana and Ambewela. The dairy products of this Company
are sold in the in the market under the trade name of “Highland”.

Moreover it contributes towards the development of the rural economy while providing the
sufficient and important nutrition to the entire nation.

Vision and Mission

- Vision – To be the “Best in Class” nutritious food and Beverage Company in Sri Lanka.

- Mission – “To be a proactive partner in achieving the targeted growth in fresh milk
production while strengthening the local dairy farmer. Modern technology supported with
continuous improvement initiatives to be applied in the processing of nutritious food and
beverages to provide our valued consumers at affordable prices.

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Production

 Narahenpita factory which was established in 1956 produces pasteurized milk, sterilized
milk, yoghurt, ice cream and butter.
 Ambewela milk factory which was established in 1974 produces milk powder and
butter.
 Digana milk factory which was established in 1989 process milk into pasteurized milk,
sterilized milk, yoghurt, ice cream and cheese.
 This Company has effective plant capacity of 200,000 liters per day.
 These products are produced using only local milk that is produced by local dairy
farmers.
 These products are mainly categorized into two varieties, namely liquid milk (e.g.
pasteurized milk, sterilized milk) and dairy products (e.g. yoghurt, ice cream , butter and
cheese)
 Highland products are produced according to the recipes which are approved by
National Milk Board.

Products categories

 Highland pasteurized milk

 Highland sterilized milk
 Highland yoghurt
 Highland curd
 Highland butter
 Highland butter
 Highland ghee
 Highland processed cheese
 Highland ice cream
 Highland milk powder
 Highland condensed milk
 Highland UHT milk

7
1.2 Industry Overview

One third of the land in Sri Lanka is considered to be agricultural and of which 75% is under the
ownership of smallholding whereas the rest is held by the State. 90% of small holdings
comprises of lands less than two hectare in size. Agriculture covers wide range of products and
services of which dairy products possess a significant presence in the market. However, domestic
dairy products are not adequate to satisfy the local demand and as a result more than 70,000
metric tons of dairy and dairy products are annually imported and which mainly comprise of full
cream milk powder (FCMP) by spending more than Rs. 50 billion a year. Dairy products include
cheese, milk and cream, milk oils and fats, casein, curdled milk and cream, kephir, buttermilk
and other acidified or fermented milk and cream, ice cream, lactose and lactose syrup, whey and
yogurt.

Among different dairy products, yoghurt can be considered as a common dairy product in Sri
Lanka and it accounts for more than 80% of the total dairy market. Yoghurt production process
is relatively simple but technology can significantly improve the effectiveness of production and
the maintenance of high quality. Only limited variations of yoghurt can be seen in the market
with different flavours such as vanilla yogurt, strawberry yogurt, treacle yogurt, fresh fruit
yogurt, chocolate, and jelly yogurt. Further, set yoghurt has a high demand in Sri Lanka
compared to stirred ones.

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1.3 Market Leadership

Majority of dairy sector in Sri Lanka is shared by few big players with a leading presence of
Milco a well-known State owned enterprise which began its operations more than 50 years ago
with the brand name of highland dairy products. Highland products range from fresh milk to
condensed milk with a view to cater the country's long-term goal of self-sufficiency of dairy
products. Current demand for milk consumption is 1,700,000 litres a day. Milco accounts for
200,000 litres a day and of which 15 percent is supplied to the fresh milk market. Milco's main
business focus remains on procurement of milk from the local farmers for production purposes.
Production takes place at its production facilities and they are sold through its sales and
distribution channels. The other major player in the dairy sector is Cargills Ceylon that has the
experience of more than 100 years in business. Product range of Cargills includes ice cream and
dairy manufacturing with brands of Cargills Magic, and recently acquired Kotmale holdings
products. Cargills accounts for 50,000 to 60,000 litres of milk a day for various productions. The
next main player is CIC group which also accounts for the dairy sector with a wide range of
products.

Sales

Milco Cargills CIC and other

9
2.0 DEMAND ESTIMATION

2.1 Factor Identification

In order to estimate the demand for the Demand Estimation Model the factors affecting the
demand of Yogurts need to be identified. These would be the “Determinants of Demand” that
affects the demand for the product under consideration (Highland Yogurts).

There are a standard set of determinants of demand that affects the demand of the product
considered. The determinants of demand could be listed as follows,

 The Price of the product

 Income level of consumers
 Price of Substitutes
 Taste of Consumers
 Effects of Advertisements
 Government Policies
 Other Factors

In order to estimate the demand of the product the information with regard for the past 5 years
are being considered.

The Price of the Product

The prices of the Highland Yogurts for the past 5 years are as follows.

 2013 to 2014 Sep – Rs.30/=

 2014 Oct to 2015 March – Rs.27/=
 2015 April to 2015 Nov – Rs. 35/=
 2015 Dec to Present – Rs. 35/=

Based on the variations in the price of the product the demand for the yogurts would changed. As
per the Law of Demand when the price of the product increases the demand would reduce and
vice-versa.

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Income Level of Consumers.

The level of the consumers’ income mainly affects the quantity demanded of the product under
consideration. In order to construct the demand model of the Highland Yogurts the average level
of income for the past 5 years have been considered.

Average monthly income for year,

 2013 - 37,916.08
 2014 - 40,621.83
 2015 - 42,433.33
 2016 - 45,534.00
 2017 - 50,259.50

When the income level of the consumers increases the Purchasing Power of the consumer
increases along with it. Therefore this leads to an increase in the demand of the good and
vice-versa.

Price of the Substitute Products

The demand of the product may be affected by the price of the substitute products. The substitute
products for the Highland Yogurt are its competitors. Therefore the prices of the substitutes for
the last year (Year 2017) are as follows,

 CIC Yogurt 80g - Rs.35

 Newdale Set Yogurt 80g - Rs.35
 Lucky Milk Yogurt 90g - Rs.35
 Kotmale Set Yogurt 80ml - Rs.35
 Richlife Set Yogurt 80ml - Rs.35
 Ambewela Yogurt Plain 80ml - Rs.35

11
When the price of a substitute product reduces the consumers may shift their demand towards the
substitute good leading to a reduction in the demand of the Yogurt and vice-versa.

Policies of the Government

The policies maintained by the government effects the demand of the product based on the
favorability or adverseness of the decision. The dairy product prices of Sri Lanka are generally
politically sensitive. Therefore it has an impact on the price of yogurts as well.

The Sri Lankan Government imposed a reduction in the prices of the dairy products in year 2015
due to an increase in the milk production for 12.1% than the previous year.

The Taste of consumers

The taste of the consumers may vary over time which would affect the demand of the good. If
the taste of consumer towards consuming Highland Yogurts changes the demand would also
change along with it.

The Effects of Advertisements

Conducting of effective advertising campaigns may change the demand of the consumers
towards the goods. It may be able to attract the number of consumers and increase the level of
demand. If the company fails to advertise effectively they may lose their consumer base.

12
2.1 Price Elasticity of Demand

The price elasticity measures the change in demand as a result of a change in its price. It can be
calculated as follows:

Price elasticity of demand = Change in quantity demanded, as a percentage of demand

Change in price, as a percentage of the price

Scope of the market, information within the market, availability of substitutes, complementary
products, disposable income, necessities, habit are the factors that affect price elasticity.

During past 5 years in Milco, price has been changed as follows:

2013 Jan – 2014 Sep - Rs. 30

2014 Oct – 2015 Mar - Rs. 27
2015 Apr – 2015 Nov - Rs. 35
2015 Dec – Present - Rs. 35

Price Quantity % change in % change in Price elasticity

quantity price
30 5,577,071
12.8% 10% 1.28%
27 4,862,811

27 6,833,387
12..8% 29.6% 0.43%
35 5,959,557

Price elasticity is usually negative. That means that it follows the law of demand; as price
increases quantity demanded decreases and vice versa. In first scenario, it is unusual to have a
positive price elasticity. Therefore, the decrease of quantity demanded may be due to other factor
changes. For example, customers’ perceptions of the product may be prejudiced by the lower
price.

In second scenario, the percentage change in demand is less the percentage change in price, the
price elasticity is lower than 1. Demand is inelastic.

13
From 2015 April to present, we can see the price is constant. If the price is increased beyond the
current price, since competitors do not follow suit demand will fall (demand is elastic). If
however, the price is dropped, competitors do follow, and little is gained in the way of extra sales
(demand is inelastic). Where this occurs, firms may be reluctant to change their prices and the
result is price stickiness.

However, products like yoghurt and other dairy items do not have much flexibility in setting
prices as the market is operated by players in an established oligopolistic nature, in which a few
companies dominate the market and are inter-dependent. Therefore, the market decides the price.

CIC Yogurt 80g - Rs.35 Kotmale Set Yogurt 80ml - Rs.35

Newdale Set Yogurt 80g - Rs.35 Richlife Set Yogurt 80ml - Rs.35
Lucky Milk Yogurt 90g - Rs.35 Ambewela Yogurt Plain 80ml - Rs.35

Attempts to change the price alone by one manufacturer would not be successful. However, the
quality which is, specially perceived in taste is a major determinant of market demand of dairy
products and therefore, product differentiation can be a strategy to face this situation. Therefore,
there is a room left for manufacturers to have leverage with respect to pricing if the products can
be assured with high quality and differentiated from other products despite the fact that all the
producers are price takers.

According to the information provided by Milco, the main factor which differentiates Highland
yogurt from the competitive products in the market is the nutritional value which is given by a
live bacteria in the highland product and as a result of the of the living period of the bacteria,
highland yogurts have a shorter duration until expiration whereas the other products have a
longer expiration date.

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2.2 Income Elasticity of Demand

Price is not the only factor that influences the quantity demanded of a product. Another
important factor is the level of money income among the consumers in the market. Income
elasticity is the measure of the responsiveness of the demand for a good to changes in consumer
income.

Income elasticity of demand = Percentage change in quantity demanded

Percentage change in income

Depending on the values of the income elasticity of demand, goods can be broadly categorized as
inferior goods and normal goods. Normal goods have a positive income elasticity of demand; as
incomes rise, more goods are demanded at each price level. Normal goods whose income
elasticity of demand is between zero and one are typically referred to as necessity goods, which
are products and services that consumers will buy regardless of changes in their income levels.
Basically, a negative income elasticity of demand is linked with inferior goods, meaning rising
incomes will lead to a drop in demand.

% change in % change in
Year Income Quantity Income
income quantity
2013 454,993 56,306,036 - - -
2014 487,462 60,520,322 7.17% 7.48% 1.04%
2015 509,200 70,719,624 4.46% 16.85% 3.77%
2016 546,408 72,363,240 7.31% 2.32% 0.32%
2017 603,114 78,361,499 10.38% 8.29% 0.80%

15
According to income elasticity, in the years of 2014, 2015, yogurt has been considered as a
luxury product. But in the years of 2016 and 2017, yogurt has become a normal good.

2.4 Regression Analysis

Regression model is used to identify the relationship between two or more variables using a
straight line. In here we have created a regression model to identify the relationship between the
price income and the Quantity demanded.

We used 60 observations for the purpose. (Observations are attached in the appendix).

Scatter Plot

Price VS Quantity Demanded

Price Line Fit Plot

1
0.9
0.8
0.7
0.6
Demand

0.5
0.4
0.3
0.2
0.1
0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Price

Demand Predicted Demand Linear (Predicted Demand)

16
By using the above scatter plot graph we can identify the relationship between the price and the
demand. We generated the above graph with the use of excel data analysis tool.

From the above chart we obtained a predicted demand at the prices (27, 30 and 35) according to
the predictable demands it shows us that there’s a positive relationship between the price and the
quantity demanded even though the price elasticity is usually negative.

Income VS Quantity Demanded

Income Line Fit Plot

9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
Demand

4,000,000
3,000,000
2,000,000
1,000,000
-
36,000 38,000 40,000 42,000 44,000 46,000 48,000 50,000 52,000
Income

Demand Predicted Demand Linear (Predicted Demand)

The above scatter plot shows the relationship between the Income and Demand. According to the
diagram when the income increases the quantity demanded has also increased. Therefore we can
identify that there is a positive relationship between the income and the quantity demanded for
yogurt.

We took 60 observations for the purpose of making the regression analysis. From the observation
we obtained below results.

17
R- Squared

R-squared is a statistical measure of how close the data are to the fitted regression line. It is also
known as the coefficient of determination, or the coefficient of multiple determination for
multiple regression.

R-squared is always between 0 and 100%:

According to the results we obtained we can say that the model explains 98.56% variability of
the response data around its mean. Even though getting a higher R- Squared is good it does not
necessarily indicate that the model has a good fit.

Adjusted R Squared

R-Squared can be misleading when assessing the goodness of fit for linear regression analysis
model. Therefore we can used adjusted r-squared for this purpose.

The adjusted R-squared is a modified version of R-squared that has been adjusted for the number
of predictors in the model. The adjusted R-squared increases only if the new term improves the
model more than would be expected by chance. It decreases when a predictor improves the
model by less than expected by chance. The adjusted R-squared can be negative, but it’s usually
not.  It is always lower than the R-squared.

18
According to our model adjusted r-squared is 96.90% which is a lower value than the r-squared
and more accurate than r-squared.

Standard Error

Standard error represents the average distance that the observed values fall from the regression
line. Conveniently, it tells how wrong the regression model is on average using the units of the
response variable. Smaller values are better because it indicates that the observations are closer
to the fitted line.

In our model standard error is quite higher which gives us a value of 673,288.

According to the model we identified we tried to build the relationship between the price, income
and the quantity demanded.

Therefore;

Qd = a+bP+cI

From the ANOVA table we obtained we can build the Quantity demanded equation as follows;

Qd = 0 - 7887P +136 I

From this equation we can obtain the Quantity of yogurts which will be demanded by the people
at a given level of price and Income.

Example.

Assume that the Price of a yogurt is Rs. 50 while Income is Rs. 100,000. The Quantity demanded
will be,

Qd = 0 - 7887P +136 I

Qd = 0- 7887*50 + 136*100,000

Qd = 13,205,650 Yogurts per month will be demanded.

F-Test

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F-Test is more suitable in using a sample to describe the population. It shows up what level the
population is described by the sample.

T-Test

T-test is used when the test statistics follows a normal distribution. It compares two averages and
tells whether they are different from each other.

3.0 COST ANALYSIS

As per the data collected from the company, the variable cost, fixed cost and total cost has been
analyzed as follows. It should be noted that the total cost has been calculated by totaling fixed
cost and variable cost, it has been assumed in this analysis that the cost of this company includes
only fixed cost and variable cost, as the company was not willing to give us detailed cost
information.

Accordingly, the fixed cost, variable cost and total cost change over the years 2013 to 2017 has
been summarized as follows. The detailed analysis has included separately.

Yea
r Total Cost Change (Year-to-Year) Change Percentage
2013 1,113,635,944.00 0 0.00%
2014 1,205,552,765.75 91,916,821.75 8.25%
2015 1,534,874,820.00 329,322,054.25 27.32%
2016 1,608,692,840.00 73,818,020.00 4.81%
2017 1,782,724,102.25 174,031,262.25 10.82%
TOTAL 669,088,158.25 60.08%

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Year Fixed Cost Change (Year-to-Year) Change Percentage
422,295,270.0
0
2013 0 0.00%
442,066,419.7
2014 5 19,771,149.75 4.68%
581,868,164.0
2015 0 139,801,744.25 31.62%
633,178,350.0
2016 0 51,310,186.00 8.82%
685,663,116.2
2017 5 52,484,766.25 8.29%
TOTAL 263,367,846.25 62.37%

Yea
r Variable Cost Change (Year-to-Year) Change Percentage
2013 691,340,674.00 0 0.00%
2014 763,486,346.00 72,145,672.00 10.44%
2015 953,006,656.00 189,520,310.00 24.82%
2016 975,514,490.00 22,507,834.00 2.36%
2017 1,097,060,986.00 121,546,496.00 12.46%
TOTAL 405,720,312.00 58.69%

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 COST (TOTAL AMOUNT)
2,000,000,000
1,800,000,000
1,600,000,000
1,400,000,000
Fixed Cost
1,200,000,000
Total Cost
1,000,000,000
Variable Cost
800,000,000
600,000,000
400,000,000
200,000,000
0
2013 2014 2015 2016 2017

COST (PERCENTAGE CHANGE)

35.00%

30.00%

25.00%
Total Cost
20.00% Fixed Cost
Variable Cost
15.00%

10.00%

5.00%

0.00%
2013 2014 2015 2016 2017

As it is shown through the above graphs, in the first two years, both fixed cost and variable cost
has been increasing constantly, with variable cost increasing fastest. Afterwards, both costs have
been increasing but at a decreasing rate. However, during the last year, the fixed cost has become
slightly constant, whereas the variable cost has increased at an increased rate, leading to increase
total cost at an increasing rate.

The cost compared with the income has been summarized below. It should be noted that the
income has been calculated by multiplying the price per unit with quantity.

22
 Price Per
Quantity Income Change (Year-to- Change
Year unit
Year) Percentage
56,306,03 1,689,181,080.0
0
2013 30.00 6 0 0.00%
60,520,32 1,634,048,694.0
2014 27.00 2 0 (55,132,386.00) -3.26%
70,719,62 2,475,186,840.0
2015 35.00 4 0 841,138,146.00 51.48%
72,363,24 2,532,713,400.0
2016 35.00 0 0 57,526,560.00 2.32%
78,361,49 2,742,652,465.0
2017 35.00 9 0 209,939,065.00 8.29%
TOTAL 1,053,471,385.00 62.37%

23
 Cost and Income (Total Amount)
3,000,000,000.00

2,500,000,000.00

2,000,000,000.00
Total Cost
Income
1,500,000,000.00

1,000,000,000.00

500,000,000.00

-
2013 2014 2015 2016 2017

Cost and Income (Percentage Change)

60.00%

50.00%

40.00%
Total Cost
30.00% Income

20.00%

10.00%

0.00%
2013 2014 2015 2016 2017
-10.00%

As it is shown in the graphs above, both the cost and income has been increasing. However, the
income has decreased slightly due to the Rs.3.00 decrease in price per unit. However, the income
has been fluctuating over the next three years, despite the price remaining constant at Rs.35.00.
The most significant increase in the increase in income has occurred in the year 2015. However,
the income increase drops sharply in the year 2016.

The cost compared with the quantity is summarized as follows. Here, only the total cost has been
considered.

24
Yea
Change (Year-to-
r Quantity Year) Change Percentage
2013 56,306,036 0 0.00%
2014 60,520,322 4,214,286 7%
2015 70,719,624 10,199,302 17%
2016 72,363,240 1,643,616 2%
2017 78,361,499 5,998,259 8%
TOTAL 22,055,463.00 39.17%

Cost and Quantity (Total Amount)

2,000,000,000.00

1,800,000,000.00

1,600,000,000.00

1,400,000,000.00

1,200,000,000.00 Total Cost

Quantity
1,000,000,000.00

800,000,000.00

600,000,000.00

400,000,000.00

200,000,000.00

-
2013 2014 2015 2016 2017

25
 Cost and Quantity (Percentage Change)
30.00%

25.00%

20.00%
Total Cost
Quantity
15.00%

10.00%

5.00%

0.00%
2013 2014 2015 2016 2017

As it is shown in the above graphs, both the total cost and quantity have been increasing in the
first two years at an increasing rate, and then continues to fluctuate over the next three years. It is
quite clear, that he total has been heavily influenced by the quantity, in this case.

3.1 Cost Minimization

Cost minimization is a financial strategy that aims to achieve the most cost-effective way of
delivering goods and services to the required level of quality. Cost minimization is not about
reducing the quality of the products and services or short changing of the customer base as
meeting customer needs is the main target of all the companies.

Even though according to the theory cost reduction results in higher profit levels and better cash
flows the main task is to identify the cost reduction strategies which do not adversely affect
revenues, the quality of products or the customer service.

During these years Milco has added new plants to increase the production levels and these
revenue expenditures has been taken as an investment for future. As the organization developed
within the past few years the company has substantially grown its cost base.

The strategies used by the Milco (Private) Limited is taken with care. As milco is based on the
dairy industry the quality of products cannot be violated at any cost reducing strategy. They

26
focus on avoiding the negative aspects such as over aggressive pruning of overhead costs, using
low quality ingredients for productions etc.

According to the information provided, the sources of cost reductions which were used by Milco
includes,

 Reduction of the wastage.

 Streamlining the production process to reduce additional costs incurred within the
production period.
 Pruning less profitable product ranges to eliminate unprofitable production costs.
 Controls over unwanted overhead costs which effects the overall cost of production.

3.2 Profit Maximization

Theoretically, Profit maximization refers to the sales level where profits are highest. Though the
general idea is Higher the sales, Higher the profits, the actual condition is different than that.

The profit maximization calculation is the point of sales where MR = MC.

(Marginal Revenue = Marginal cost)

 Marginal Revenue – Per unit selling price of a sales item. Marginal revenue appears as a
line sloping down to the right on a graph as per the theory that when the sales becomes
higher the price becomes lower.

 Marginal Cost – Per unit cost of a sales item. MC is generally shown as a line that
slopes downward and then comes back up. This is based on the fact that per-unit costs
will decrease to a certain point as you increase the number of units produced at a

27
 production plant; then, once the entity reach capacity, the costs will increase as the
company either open a new plant or outsource production to other companies.

To maximize profits, the companies must be diligent in cutting frivolous costs and boost
productivity among employees. This is an ongoing process that often faces many challenges. The
business's profits will serve two purposes.
- The profits will be reinvested in the business to allow the business to grow.
- The profits will also be distributed to the business owner.

According to the information provided by Milco (Private) Limited regarding their main product
under Highland Brand, the profit maximizing strategies followed by the company is as follows,

 Analyzing how the revenue is being spent.

According to Milco, Overhead is one of the biggest categories of expenses that the company
face. Frequent review on the other categories of expenses and if there is a large increase in a
specific category during the years, the analysists tends to look into the details of that category.

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As Highland is active in advertising though the costs are high, the advertising campaign is
paying off in increased sales, then the higher expense is known to be worth it.

 Reviewing and analyzing the cost structure of the products.

Milco tends to perform a detailed review when the cost of raw materials and related costs
increase, according to Milco, reviewing their cost structure on a regular basis helps the company
keep track of costs that are on the rise before the cost is too high.

 Motivating the Employees

Milco believes when employees are happy, more quality work gets accomplished in a shorter
amount of time. As employee motivation is highly important to the company’s production levels
Milco uses simple motivation techniques.

3.3 Economies of Scales and Diseconomies of scales

Economies of Scales

 Specialization

As Milco Private Limited is the largest dairy products producer in Sri Lanka it employees a large
amount of employees. This allows the firm to divide the job into smaller tasks and duties. These
individual tasks are assigned to separate workers. By this way workers spend all their work time
on one particular task and the individual workers becomes specialized. Thereby, the average unit
cost per product will reduce.

 Efficient Capital

At Milco the most efficient machines and equipment are based on new technology and have high
production capacity compared to the other firms in the industry. As Milco is with a larger scale
production company owned by the government it can afford such equipment and benefit from

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their full capacity. At full utilization such machinery or equipment achieves lower production
cost per unit. The other firms in the market having small scale production either cannot afford
resources for such equipment or cannot utilize such machinery and equipment to its full capacity
due to internal limitations.

 Negotiation Power

As Milco is a larger firm owned by the government it is in a powerful position to negotiate better
outcomes with parties such as suppliers, labor unions, financial institutions. When purchasing
raw material, it can obtain better trade discounts by bulk purchasing. They can negotiate lower
wages and salaries because people are eager to work at large companies even at low wages (not
below minimum wage). Financial institutions such as banks and other financial institutions are
more willing to offer loans at lower interest rate to well-established firms having large scale
production.

 Learning

As a well-established firm grown in Sri Lanka, they learn from both experience and research. At
small scale, firms are typically young having inefficient structure and processes. It has developed
gradually by learn-by-doing and become more and more efficient. Firm also learn from research
and as it is a larger firm can afford high research costs which result in better processes and new
formulas pushing their production cost per unit even lower.

Diseconomies of Scale

- Difficulties of management:

As a firm expands, its complexities and problems of management increase. Co-

ordination, control and supervision becomes difficult. Lack of effective supervision and control

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might lead to inefficiencies, frauds and overall mismanagement. Therefore, to minimize the
overall management failure, Milco has maintained proper co-ordination and supervision in
managing its resources.

- Co-ordination becomes difficult:

The tasks of organization and co-ordination becomes increasingly difficult and it would be less
flexible for co-ordination. Management would face numerous problems in running the
organization.

- Difficulties in decision making:

When the company grows the company will not be able to make quick decisions. Various
individuals in the firm have to be consulted and many factors have to be considered when
making decisions. This results in delayed decisions. The firm would be slow in reacting to
problems and issues which can hinder its development and cannot the firm will be unable to take
advantage of opportunities.

- Financial difficulties:

A large scale firm requires a large amount of capital. Meeting the high funds requirements is not
always possible. In case of dull capital markets, investors may not be ready to invest in the firm.
Banks may not come forward to lend loans beyond a certain limit as the risk faced by them is
high. Difficulty in obtaining sufficient funds may hinder further expansion and growth. But as it
is a fully government owned firm the financial difficulties can be minimized for a certain extent.

- Risk increases:

Business risks also increase with the increase in scale. The larger the output, the greater would be
the loss, if products are not sold out in the market. Any error in judgment can cause huge losses
to the business.

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 - Labor dis-economies:

There is high level of mechanization and division of labor is implemented. Workers do the same
task for a number of years. This results in monotony, boredom and lack of interest in the job.
Their concentration and motivation levels are low leading to absenteeism, accidents, grievances
and industrial disputes.

- Marketing dis-economies:

When the industry expands, competitor becomes intense. Retention of existing customers and
attracting new customers become difficult. Substantial amount of money needs to be spent
on advertising and sales promotion activities. Distributors may demand higher profit margins,
increased credit period, etc. This results in higher expenses and lower profits for the large scale
manufacturer.

- Increase in factor costs:

As a firm grows and production level increases, the demand for factors of production (land,
labor, capital) increases. Factors of production need to be paid more (land-rent, labor-wages, and
capital-interest). This increases the cost of production and lowers profit margins.

- Problem of oversupply:

Where there are many large scale firms in an industry, the problem of over supply might arise.
Production may be more than the actual demand which would lead to a fall in prices. The firm
would also face the problem of huge unsold stock. They might have to offer high discounts to
clear their stocks.

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4.0 REFERENCES

- http://www.milco.lk/ - Official website of Milco (Pvt) Limited

- Management Level P2 Advanced Management Accounting - CIMA official study text
Kaplan publishing
- Managerial Economics - Book by Brian McCann and Luke M. Froeb
- https://www.docsity.com/en/demand-forecasting-managerial-economics-lecture-notes/
167821/ - Demand Forecasting Study Notes
- https://analystprep.com/cfa-level-1-exam/economics/effects-economies-diseconomies-
scale-production/ - CFA Level 1 Curriculum
- http://personal.unizar.es/jamolina/_/microeconomia/Unit%2071.pdf - Minimizing Costs
And Maximizing Profits - J. Alberto Molina – J. I. Giménez Nadal

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5.0 APPENDIX

- Sales Quantity

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- Price sheet

- F - Test

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- t – Test

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