Economies and diseconomies of scale

Economies of scale Factors that cause average unit costs to fall as the scale of output increases in the long run.

Diseconomies of scale Factors causing average costs to rise as the scale of output increases in the long run

Two ways a firm can grow Internal growth External growth

Internal growth Firm expands own sales or output Investment in new machinery Employ more staff

External growth Created by takeover and merger activity Research shows that on average takeovers and mergers fail to improve efficiency

Economies of scale A pottery that could produce 100 vases at £5 each may be able to produce 1000 vases at £4.50 per unit. The total cost rises (from £500 to £4500), but the cost per unit falls. Assuming the firm sells the vases for £6 each, the profit margin rises from £1 to £1.50 per vase.

Bulk buying economies As a business grows it will place larger orders with its suppliers, which enables them to negotiate discounts which will reduce their costs.

Technical economies of scale Using more machinery and less labour will usually generate cost savings New machinery may be less wasteful

Specialisation When firms grow there is greater potential for managers to specialise in a particular task

Financial economies of scale Successful small firms grow into large firms Small firms are often over reliant on one product or customer

Marketing economies of scale Large firms can spread the cost of a large sales force over multi million pound sales.

Other benefits of size Reduced risk Increased capacity utilisation

Diseconomies of scale Poor employee motivation Poor communication Poor managerial coordination

Combining economies and diseconomies of scale Growth creates both economies and diseconomies of scale

What can managers do about diseconomies of scale? Corrective action required Poor motivation Delegate decision making power Job enrichment Split the business up into: Autonomous work groups Profit centres Poor communication Improve employee motivation as above Send managers on training courses Create new communication structures such as work councils Poor coordination Decentralise Empowerment Wider spans of control