Horizontal Boundaries of the Firm Flashcards
Define Economies of Scale
Bigger is better
the production process for a specific good or service exhibits EoS over a range of output when average cost[AC] declines over that range
e. g. AC declines as output increases, then Marginal Cost (MC) must be less than AC
e. g. AC increases, MC must exceed AC = diseconomies of scale
Define Average Cost
cost per unit of output
u-shaped AC curve
AC declines initially as FC is spread over additional units of output.
AC eventually rise as production runs up against capacity constraints = capacity constraints kick-in (diseconomies of scale appear)
- usually in Short-run
as firms trying to expand output run up against capacity constraints
L-shaped AC curve
- if U- small and large firms would have higher costs than medium firms = but large firms rarely at cost disadvantage
- AC decreases until MES
- firms operating beyond MES have similar average costs
Long Run
- firms expand by building new facilities
- if new facilities operate efficiently, then l-shaped
Define minimum efficient scale (MES)
the lowest point on a cost curve at which a company can produce its product at a competitive price
What does economies of scale do?
- Create cost advantages
- Determine market structure and entry
- Affect the internal organisation of firms
- Determine firms’ horizontal boundaries
Standard sources of Economies of Scale and Scope
§ Indivisibilities
□ Certain inputs can’t be scaled down below a minimum
□ Lead to FC and economies of scale and scope
§ Spreading of fixed costs
§ Technology Trade-offs
§ Division of Labour (Specialisation)
Define Economies of Scope
• Cheaper for one firm to produce both X and Y, than for two different firms to specialise in X and Y each
§ TC(QX, QY) < TC(QX, 0) + TC(0, QY)
§ TC(QX, QY) – TC(0,QY) < TC(QX, 0)
Production of Y reduces the incremental cost of producing X
Indivisibilities
Input cannot be scaled down below a certain minimum size
FC arise when there are Indivisibilities in production
- scale and scope economies at different levels
Product Level
Plant Level
Multiplant Level
Spreading of fixed costs
□ Product-Specific FC (or, sector-specific?)
e. g.
- special equipment;
- R&D;
- Specialised equipment
- specialised knowledge/labour
- training expenses;
- setup costs;
- simple production processes]
Technology Trade-offs
look at graphs
Division of Labour (Specialisation)
- to become specialists individuals or firms must make substantial investments- but only is demand justifies it i.e. extent of the market
e. g. doctors - look at graphs
Special sources of Scale and Scope:
§ Economies of Density
§ Purchasing
§ R&D
§ Advertising/Marketing/Brand Management e.g. umbrella branding
§ Production and Cube-Square Rule
Inventories
Economies of Density
cost savings that arise within the transportation network due to greater geographic density of customers
Result from:
- increasing the no. of customers using a given network
- reducing the size of the area = reduce cost of network & maintain no. of customers
Purchasing
- bulk buying leads to discounts
Why suppliers care:
- less costly to sell to single buyer
- bulk purchaser has more to gain from best price hence is more price sensitive
- supplier may fear costly disruption to operations
Advertising
(Cost of sending a message/ Number of potential consumers receiving the message)
Advertising cost per consumer:
(Number of actual consumers as a result of message/ Number of potential consumers receiving the message)
Larger firms enjoy lower advertising costs per consumer
- lower costs per message per potential customer
- higher advertising reach
Advertising Reach and umbrella Branding
- effectiveness of a firm’s ad may be higher if that firm offers a broad product line under a single brand name
e. g. Samsung mobile may encourage purchase of TV
R&D
All firms can lower average costs by amortizing R&D expenses over large sales volumes
- does not imply larger firms are more innovative than smaller firms
Physical Properties of Production
Economies of scale may arise
Cube-Square Rule
production capacity is proportional to the volume of the production vessel
As capacity increases, AC of producing at capacity decreases, as ratio of Surface Area: Volume decreases
- physical properties of production often allow firms to expand capacity without comparable increases in costs
Inventories
firms carry inventory to minimize the chances of running out of stock
Inventory costs drive up AC of good that are actually sold
Inventory costs are proportional to the ratio of inventory holdings : sales
Limitations of Economies of Scale and Scope
Diseconomies of Scale: • Labour Costs (Wages) and Firm Size • Spread too thin • Bureaucracy: • Incentives and co-ordination • Impact upon intrapreneurship and innovation?
Diseconomies of Scope
• Umbrella branding?
• ‘Conflicting out’?
• Strategic fit?
What are Complementaries
Synergies among organizational practices
- the benefits of introducing one practice are enhanced by the presence of others
e. g. fast turn around of flights and not catering
Concept of complementaries known as strategic fit
What is Strategic Fit
- Complementarity that yields economies of scope
- Means that (simple/piecemeal) copying of corporate strategy by rivals unproductive
- Porter: Strategic fit is essential for long term competitive advantage
