ECONOMY OF SCALE
Economies of scale are reductions in average costs attributable to production volume increases. They typically are defined in relation to firms, which may seek to achieve economies of scale by becoming large or even dominant producers of a particular type of product or service. A distinction can be made between internal and external economies of scales. Internal economies of scale occur when a firm reduces costs by increasing production. External economies of scale occur when an entire industry benefits from expansion; for example, through the creation of an improved transportation system, a skilled labor force, or by sharing technology.
Economies of scope are reductions in average costs attributable to an increase in the number of goods produced. For example, fast food outlets have a lowe+r average cost producing a multitude of goods than would separate firms producing the same goods. This occurs because the preparation of the multiple products can share storage, preparation, and customer service facilities (joint production).
ECONOMIES OF SCALE
The basic notion behind economies of scale is well known: As a plant gets larger and volume increases, the average cost per unit of output is expected to drop. This is partially because relative operating and capital costs decline, since a piece of equipment with twice the capacity of another piece does not cost twice as much to purchase or operate. If average unit production cost = variable costs + fixed costs/output, one can see that as output increases the fixed costs/output figure decreases, resulting in decreased overall costs.
Plants also gain efficiencies when they become large enough to fully utilize dedicated resources for tasks such as materials handling. The remaining cost reductions come from the ability to distribute non-manufacturing costs, such as marketing and research and development, over a greater number of products. This reduction in average unit cost continues until the plant gets so big that coordination of material flow and staffing becomes very expensive, requiring new sources of capacity.
SPECIALIZATION. In a small firm, labor and equipment must be used to perform a number of different tasks. It is more difficult for labor to become skilled at any one of them and thereby realize the gains in productivity and reduction in per-unit costs that specialization permits. In the same way, management functions cannot be as specialized in a smaller firm. Supervisors may have to devote time to screening job applicants, a task usually more efficiently handled by a personnel department in a larger firm. Executives may have to divide their attention between finance, accounting, and production functions that could be handled more proficiently by departments specializing in each of these areas in a larger firm.
INTERNAL ECONOMICS:-
1. Economies related to a particular industry. They are derived from the concentration of the industry in one place and differ between industries. They might involve cheaper training facilities if many firms want to train their employers or marketing economies when several firms want the same kind of raw material. They can be realized through trade associations which are producers' unions, which can e.g. advertise the industry generally, thus raising the revenue of all the firms included.
2. Economies related to industrialization. If there is a great concentration in specific place, e.g. many people come to look for job there. Usually the communication expenses (maintenance of roads) can be shared. The activities of the essential services sector multiply, providing more advantages to firms in the industrialized area.
3. Economies related to society. The provision of roads, schools etc. is largely the responsibility of the state. As industrialization increases the provision of these items increases giving further advantages to firms in the area.
ECONOMIES OF SCOPE
According to David Kass in his 1998 article, "Economies of Scope and Home Healthcare," economies of scope exist if a firm can produce several product lines at a given output level more cheaply than a combination of separate firms each producing a single product at the same output level. Economies of scope differ from economies of scale in that a firm receives a cost advantage by producing a complementary variety of products with a concentration on a core competency. While economies of scope and scale are often positively correlated and interdependent, strictly speaking the benefits from scope have little to do with the size of output.
For instance, in the paper products industry it is common for large firms to produce their own pulp, the primary ingredient in paper, before manufacturing the paper goods themselves. However, smaller firms may have to purchase pulp from others at a higher net cost than the large companies pay. The savings from producing both pulp and paper would be an economy of scope for the large producers, although the large companies probably also have economies of scale that make it feasible to invest in pulping operations in the first place.
In another example, banks have economies of scope when they offer a variety of related financial services, such as retail banking and investment services, through a single service infrastructure (i.e., their branches, ATMs, and Internet site). Clearly, the costs of providing each service separately would be much greater than the costs of using a single infrastructure to provide multiple services.
Research concerning hospitals has suggested that other types of services, such as pediatric care, may have economies of scope. With increasing competition and emphasis on service, economies of scope are necessary for hospitals to provide these services profitability.
DISECONOMIES OF SCALE
When a firm grows beyond the scale of production that minimizes long-run average cost, diseconomies of scale may result. When diseconomies of scale occur the firm sees an increase in marginal cost when output is increased. This can happen if processes become "out of balance," or when one process cannot produce the same output quantity as a related process. Diseconomies of scale also can occur when a firm becomes so large that:
· Transportation costs increase enough to offset the economies of scale
· Monitoring worker productivity becomes too imperfect or costly
· Coordinating the production process becomes too difficult
· Frequent breakdowns result
· Maintaining efficient flows of information becomes too expensive
· Workers feel alienated and become less productive
· The focus of the firm is reduced, leading to inefficiencies and loss of strategic position
Economies of scale are reductions in average costs attributable to production volume increases. They typically are defined in relation to firms, which may seek to achieve economies of scale by becoming large or even dominant producers of a particular type of product or service. A distinction can be made between internal and external economies of scales. Internal economies of scale occur when a firm reduces costs by increasing production. External economies of scale occur when an entire industry benefits from expansion; for example, through the creation of an improved transportation system, a skilled labor force, or by sharing technology.
Economies of scope are reductions in average costs attributable to an increase in the number of goods produced. For example, fast food outlets have a lowe+r average cost producing a multitude of goods than would separate firms producing the same goods. This occurs because the preparation of the multiple products can share storage, preparation, and customer service facilities (joint production).
ECONOMIES OF SCALE
The basic notion behind economies of scale is well known: As a plant gets larger and volume increases, the average cost per unit of output is expected to drop. This is partially because relative operating and capital costs decline, since a piece of equipment with twice the capacity of another piece does not cost twice as much to purchase or operate. If average unit production cost = variable costs + fixed costs/output, one can see that as output increases the fixed costs/output figure decreases, resulting in decreased overall costs.
Plants also gain efficiencies when they become large enough to fully utilize dedicated resources for tasks such as materials handling. The remaining cost reductions come from the ability to distribute non-manufacturing costs, such as marketing and research and development, over a greater number of products. This reduction in average unit cost continues until the plant gets so big that coordination of material flow and staffing becomes very expensive, requiring new sources of capacity.
SPECIALIZATION. In a small firm, labor and equipment must be used to perform a number of different tasks. It is more difficult for labor to become skilled at any one of them and thereby realize the gains in productivity and reduction in per-unit costs that specialization permits. In the same way, management functions cannot be as specialized in a smaller firm. Supervisors may have to devote time to screening job applicants, a task usually more efficiently handled by a personnel department in a larger firm. Executives may have to divide their attention between finance, accounting, and production functions that could be handled more proficiently by departments specializing in each of these areas in a larger firm.
INTERNAL ECONOMICS:-
- Technical economies of scale:
- Expensive specialist capital machinery e.g robotic technology in the production of vehicles
- Specialisation of the workforce to boost factor productivity – division of labour
- The law of increased dimensions or the “container principle”
- Learning economies e.g. learning by doing: Unit costs of production typically decline in real terms as a result of production experience as businesses improve their production methods and cut waste. Evidence across a wide range of industries into so-called “progress ratios”, or “experience curves”, indicate that unit manufacturing costs typically fall by between 70% and 90% with each doubling of cumulative output
- Marketing economies of scale and monopsony power : A large firm can spread its advertising and marketing budget over a much larger output and it can also purchase its factor inputs in bulk at discounted prices if it has monopsony power in the market (monopsony power is becoming important)
- Financial economies of scale: Larger firms have access to credit facilities, with favourable rates of borrowing. In contrast, smaller firms often face higher rates of interest on their overdrafts and loans. Businesses quoted on the stock market can normally raise fresh money (extra financial capital) more
- Network economies of scale : Some networks and services have huge potential for economies of scale. That is, as they are more widely used (or adopted), they become more valuable to the business that provides them. Think about network economies exploited by EBAY in online auctions and the rapid expansion of air transport networks by the low-cost airlines. The marginal cost of adding one more user to the network is close to zero, but the resulting financial benefits may be huge because each new user to the network can then interact, trade with all of the existing members or parts of the network.
1. Economies related to a particular industry. They are derived from the concentration of the industry in one place and differ between industries. They might involve cheaper training facilities if many firms want to train their employers or marketing economies when several firms want the same kind of raw material. They can be realized through trade associations which are producers' unions, which can e.g. advertise the industry generally, thus raising the revenue of all the firms included.
2. Economies related to industrialization. If there is a great concentration in specific place, e.g. many people come to look for job there. Usually the communication expenses (maintenance of roads) can be shared. The activities of the essential services sector multiply, providing more advantages to firms in the industrialized area.
3. Economies related to society. The provision of roads, schools etc. is largely the responsibility of the state. As industrialization increases the provision of these items increases giving further advantages to firms in the area.
ECONOMIES OF SCOPE
According to David Kass in his 1998 article, "Economies of Scope and Home Healthcare," economies of scope exist if a firm can produce several product lines at a given output level more cheaply than a combination of separate firms each producing a single product at the same output level. Economies of scope differ from economies of scale in that a firm receives a cost advantage by producing a complementary variety of products with a concentration on a core competency. While economies of scope and scale are often positively correlated and interdependent, strictly speaking the benefits from scope have little to do with the size of output.
For instance, in the paper products industry it is common for large firms to produce their own pulp, the primary ingredient in paper, before manufacturing the paper goods themselves. However, smaller firms may have to purchase pulp from others at a higher net cost than the large companies pay. The savings from producing both pulp and paper would be an economy of scope for the large producers, although the large companies probably also have economies of scale that make it feasible to invest in pulping operations in the first place.
In another example, banks have economies of scope when they offer a variety of related financial services, such as retail banking and investment services, through a single service infrastructure (i.e., their branches, ATMs, and Internet site). Clearly, the costs of providing each service separately would be much greater than the costs of using a single infrastructure to provide multiple services.
Research concerning hospitals has suggested that other types of services, such as pediatric care, may have economies of scope. With increasing competition and emphasis on service, economies of scope are necessary for hospitals to provide these services profitability.
DISECONOMIES OF SCALE
When a firm grows beyond the scale of production that minimizes long-run average cost, diseconomies of scale may result. When diseconomies of scale occur the firm sees an increase in marginal cost when output is increased. This can happen if processes become "out of balance," or when one process cannot produce the same output quantity as a related process. Diseconomies of scale also can occur when a firm becomes so large that:
· Transportation costs increase enough to offset the economies of scale
· Monitoring worker productivity becomes too imperfect or costly
· Coordinating the production process becomes too difficult
· Frequent breakdowns result
· Maintaining efficient flows of information becomes too expensive
· Workers feel alienated and become less productive
· The focus of the firm is reduced, leading to inefficiencies and loss of strategic position