Economies of Scale
- Make enough products and you can lower the average cost (cost per unit)
o Fixed cost while getting more profit (fixed cost could be renting a facility)
- Diseconomies of scale: grow too much and you cannot operate your business efficiently.
o More employees = miscommunication, misunderstandings, and poor management
- Diagram Description automatically generated
AC = average cost, TC = total cost, Q = quantity produced
Total cost = total fixed cost + total variable cost
Internal Economies of Scale
- Economies of scale for a particular organization, rather than an industry.
- Two types: technical or financial
- Technical: large firms, high fixed cost, high fixed cost of equipment and machinery (stuff like machinery, deals with product)
- Financial economies: large firms can borrow money at lower rates of interest
- Lower interest rates = less risky to financiers (so more likely to be invested in)
- Borrowing large amounst of money reducing the cost of borrowing finances (interest rates!)
- Managerial
o Dividing managerial role
o Fall in average cost, since more productivity
o Sole traders can’t do this
- Specialization economies
o Division of labour in the workforce
o i.e. training some people to do one job only
o they can do it better, increases productivity, reduces cost
- Marketing economies
o Large firms benefit from selling in bulk
o High advertising costs can be reduced by using the same strategy globally (for international firms)
- Purchasing economies
o Large firms buy supplies in bulk
o They get the biggest discounts when buying in bulk (since they are large orders)
- Risk bearing economies
o Conglomerates can spread fixed costs across a wide range of business operations (review!)
Internal diseconomies of scale
- Lack of contral and coordination (i.e. messy business management)
- Poor working relations
- Outsourcing (less vertical integration)
- Bureaucracy (dealing with magamente)
- Complacency
External economies of scale
- Technological progress
o Tech progress can offer savings
- Improved transportation networks
o Better transportation = less cost transporting goods
o Also improved logistacl network (i.e. pipelines), more efficient delivery therefore lower costs
- Abundance of skilled labour
o If there’s lots of educating and trained labour, it can reduce cost of recruitment and training (because there are less people you need to train; you can just hire them)
- Regional specialization
o Some places have a repuation for specific goods and products
o Because of this reputability, companies can charge a premium price
External diseconomies of scale
- Higher rents (i.e. needing to move to a larger building, empty office spaces during COVID)
- Local market conditions for pay and financial rewards.
o i.e. employees expect higher pay in Toronto because of larger cost of living
- Traffic congestion (takes longer + more fuel to transfer goods)
o Employees don’t want to drive into the city
- Context specific problems
Internal vs external growth
- Internal growth: business grows using its own capabilities and resources
- External growth: how you grow from outside. Deals with acquisitions of other businesses
Internal growth
- Changing prices, effective promotions, product innovation, increased distribution, preferential credit for customers, capital expenditure, staff training and development, and providing overall value for money
Advantages of Internal growth
Adv
- Better control and coordination of money and corporate culture
- Inexpensive
- Less risky and external growth
Disadv
- Diseconomies of scale
- Ownership needs to be restructured.
- Dilution of control and ownership
- Growth is slower (since you are using your own resources)
External growth
Adv
- Quikcer than organic growth
- Synergies
- Reduced competition
- Economies of scale
- Spreading of risks ??
Disadv
- More expensive than internal growth
- More risks
- Regulations (i.e. government)
- Potential disecomenies of scale
- Organizational culture clash
Ways to increase external growth
Mergers and Acquisition
- Mergers: two companies agree to combine and make a new company with a different legal identitity
- Acquisition: with permission of board of directions, a company “eats up” another company
o Like pacman eating
o The acquiring company takes over the other company
Adv
- Greater market share
- Economies of scale
- Synergy survival
- Diversification
- Gain entry into new market
Disadv
- Redundancies
- Conflict
- Culture clash
- Loss of control
- Diseconomies of scale
- Regulatory problems
Internal economies of scale:
Financial economies of scale: banks give lower interest rates to bigger businesses (because they are lower risk)
Marketing economies of scale: spread fixed cost of marketing across range of brands and products. IF a company doubles sales, it doesn’t need to double marketing expenses
Managerial economies of scale: large business can hire more management, which can be efficient and productive
Technical economies of scale: buy large scale machinery which is efficient
Purchasing economies of scale: you can buy in bulk, save money
Risk bearing economies of scale: sell larger range of products, so if one fails not big deal
Specialization: hire specialized people, less training, more productive
Internal vs external growth
Internal growth: organization grows without the help of an external organization or partner firm. Bank loans doesn’t count towards external growth
Internal growth benefits:
- Corporate culture
- Increased market share
- Rights of control of organization
- Avoid high price of external growth
