Slides 14 Flashcards
What are economies of scale?
Economies of scale occur when the average production cost of a good declines as the number of units produced increases.
What happens to average costs as production increases?
Average costs decline up to the minimum efficient scale (MES) of production.
Define minimum efficient scale (MES).
A firm’s average costs (AC) will decline as fixed costs are spread across increasing production.
What do total costs (TC) represent?
The total costs that a firm accumulates during a year.
What are variable costs (VC)?
Costs that fluctuate with the quantity of products manufactured, e.g., raw materials, labor hours, utility costs.
What are fixed costs (FC)?
Costs that do not fluctuate with quantity, e.g., land, buildings, and equipment.
How is average cost (AC) calculated?
Average cost (AC) = Total Costs (TC) / Quantity (Q).
What is the significance of fixed costs in economies of scale?
Fixed costs are the most common source of economies of scale and arise when there are indivisibilities in the production process.
What is an example of an indivisible fixed cost?
Factory buildings, factory machines, and delivery vehicles.
What are product-specific fixed costs?
Costs that require unique, non-variable expenses for the manufacturing and sale of a specific product, e.g., R&D costs.
What happens to average costs when capacity constraints are met?
Average costs will continue to decrease until capacity constraints are met.
What characterizes capital-intensive industries?
Industries where a significant percentage of total costs are fixed costs, requiring larger initial investments.
What characterizes materials or labor-intensive industries?
Industries where most production costs go to variable raw materials or labor.
What are advertising economies of density?
Cost savings that arise due to a greater geographic density of customers.
What is the learning curve?
Advantages that flow from accumulating experience and know-how.
List some benefits of the learning curve.
- Better understanding of customer preferences
- Ways to make product higher quality
- Ways to reduce damage during shipping
True or False: Economies of scale are less powerful in capital-intensive industries.
False.
Fill in the blank: Strategy can be defined as the determination of the basic long-term goals and objectives of the enterprise, and the adoption of a course of action and the allocation of resources necessary for carrying out these goals. – _______
Alfred Chandler
Who defined competitive strategy as about being different?
Michael Porter
What are the five most important concepts of strategic management?
- Value Proposition
- Key Activities
- Core Competencies
- Resource Constraints
- Principal-Agent Issues
What is a value proposition?
Something that solves a customer’s problem or satisfies a customer’s need.
What are key activities in strategic management?
The most important operations a company must perform in order to make its business work.
What are core competencies?
Unique strengths that allow a company to perform its key activities better than its competitors.
What do resource constraints refer to?
The limitations on strategic actions due to the amount of money, time, natural resources, and technical skills a company possesses.
What are principal-agent issues?
Concerns about who is really in charge and whether decisions benefit managers or owners more.
What is Economies of Scale?
Lowering the average cost per unit by increasing output or decreasing variable costs.
What is the Learning Curve?
Advantages that flow from accumulating experience and know-how.
What are benefits of the Learning Curve?
- Better understanding of customer preferences
- Ways to make product higher quality
- Ways to reduce damage during shipping
How does the Learning Curve differ from Economies of Scale?
The learning curve is more prevalent in labor-intensive industries, while economies of scale focus solely on cost.
Why are Economies of Scale important?
- Understand potential market of customers
- Firms operating efficiently are less likely to face competition
- Lower average unit cost increases profit
What does ‘Scaling’ refer to?
Simply growing a company’s operations by maximizing output and reaching new customers.
What are Diseconomies of Scale?
As firms grow larger, they become harder to manage, making incremental changes and leaving them vulnerable to large industry changes.
What is a critical forecasting problem for firms?
Firms need to know the potential customer base before investing in fixed assets.
What is the significance of break-even analysis?
It ensures that the fixed asset investment is worthwhile.
What are the challenges of achieving Economies of Scale?
Achieving economies of scale is expensive and often requires outside investors, leading to potential agency problems.
How can firms measure Economies of Scale through Income Statements?
- Decline in COGS as a percentage of revenue indicates better per-unit costs
- Decline in SG&A expenses as a percentage of revenue suggests increased efficiency
- Increasing operating margins show better overhead distribution
What does the Asset Turnover Ratio indicate?
Increases in this ratio suggest better asset utilization as the company scales.
What is an example of Economies of Scale from history?
Henry Ford’s assembly line is considered the birth of mass production and modern economies of scale.
What are Economies of Scope?
Cost savings achieved by increasing the variety of goods and services produced.
What is required for a firm to achieve Economies of Scope?
Leveraging core competencies when manufacturing or selling new products.
What are the financial stability reasons for firms to diversify?
- Generate revenue during inconsistent sales periods
- Invest in future-relevant industries
- Move to new industries when losing sales
What is strategic fit in Economies of Scope?
Utilizing existing economies of scale within economies of scope, such as sharing raw materials and production lines.
What are the revenue benefits of Economies of Scope?
- More products to sell
- Encouraging customers to buy more through bundling
- Maintaining brand loyalty
What is Unrelated Diversification?
When a firm expands without utilizing economies of scope, allowing less dependency on a single industry.
When should firms avoid diversifying?
- When they lack economies of scope
- When they lack core competencies
- When they lack necessary resources
What can result from misunderstanding or neglecting diversification?
- Financial losses from new market investments
- Brand damage from failing new products
What is a real-life measurement of success in Economies of Scope?
Revenue growth should outpace expense growth, leading to improved gross margins.
What does increased Asset Turnover Ratio in Economies of Scope indicate?
Utilization of fixed assets across multiple product lines.
What is the concept of Economies of Scope?
Utilizing fixed assets across multiple product lines
This allows companies to leverage their resources more efficiently.
What does the term ‘core competencies’ refer to?
Essential skills and capabilities that a company possesses
These competencies enable companies to compete effectively and innovate.
What notable product did Sony introduce in 1946?
Japan’s first tape recorder
List three core competencies of Sony in 1946.
- Understanding radio and radio waves
- Recording sound onto tapes
- Making small electronic devices
When did Sony become the world leader in microelectronics?
After introducing Japan’s first tape recorder in 1946
What significant transition did Sony undergo in 1981?
Shift from analog technology to digital technologies
What major acquisition did Sony make in 1989?
Purchased Columbia Pictures
Fill in the blank: Sony created the _______ in 1994.
PlayStation
What was Billy’s initial business idea?
Building and selling custom backpacks
How much fabric did Billy need to build 12 backpacks?
36 units of fabric (3 units per backpack)
What was the selling price of each backpack on Etsy?
$150
True or False: Etsy charges a 10% commission fee on all sales.
False
What was Billy’s average cost per backpack after selling 12 bags?
To be calculated based on total costs
In Scenario 2, how many bags did Billy decide to produce?
100 bags
What was the total cost of utilities for Billy in Scenario 2?
$100
List the raw materials Billy purchased for Scenario 3.
- 4,000 units of black fabric @ $10.00/unit
- 7,500 zippers @ $5.00/unit
What was the total rent Billy paid for the garage in Scenario 2?
$1,500 ($500/month for 3 months)
What advertising expense did Billy incur in Scenario 4?
$1,000/month
What new products did Billy decide to sell in Scenario 5?
- Smaller everyday backpack
- Toiletry bag
How much did it cost to develop and maintain the new website in Scenario 5?
$20,000
True or False: The average cost per unit is a good measurement when selling multiple products.
False
What was the total cost of sewing machines purchased for Scenario 5?
$14,000
Fill in the blank: Billy hired _______ employees for production in Scenario 5.
6
What was the total advertising expense for Scenario 5?
$2,000/month
What was the company’s average cost per unit in scenario 5?
The average cost per unit in scenario 5 was not provided in the text.
Is average cost per unit a good measurement when selling multiple products?
No, because it may not accurately reflect the cost structure of different products.
What was the COGS/Revenue Ratio?
The COGS/Revenue Ratio was not explicitly stated.
How much were the investors willing to invest in Billy’s company?
$250,000 for 25% of Billy’s company.
What new product line did the investors want Billy to expand into?
Travel shoes.
What was the rent for the new factory/warehouse?
$10,000/month.
What were the total utilities costs?
$25,000 total.
What was the total machine cost for producing shoes?
$40,000, depreciated over 5 years.
How much did redeveloping and maintaining the website cost for scenario 6?
$30,000.
What were the advertising fees increased to?
$3,000/month.
What percentage are the commission fees now?
4%.
How many shoes were sold, and at what price per unit?
1,000 shoes sold for $150/unit.
Fill in the blank: Shoe Fabric was 2,500 units @ _______ per unit.
$12.00/unit.
Fill in the blank: Shoe Rubber was 2,250 units @ _______ per unit.
$25.00/unit.
Fill in the blank: Shoe Foam was 2,250 units @ _______ per unit.
$5.00/unit.
Fill in the blank: Shoe Laces were 2,200 units @ _______ per unit.
$0.50/unit.
Was the Return on Sales (Profit Margin) more or less than scenario 5?
The comparison to scenario 5 was not explicitly stated.
What is the concept of Economies of Scope?
It refers to the cost advantages that a business obtains due to the variety of products it produces.
