Economies of scale and Economies of scope

Economies of scale and Economies of scope

Economies of scale are situations where the cost of producing one unit of a good or services decreases as the volume of production increases. Economies of scale tend to occur in industries with high capital costs in which those costs can be distributed across a large number of units of production. It can be applied to efficiencies assorted with increasing or decreasing scale of production changes in the output of a single product type and supply of side changes such as level of production.

Economies of scope are conceptually similar to economies of scale. However, it refers to efficiencies assorted with increasing or decreasing the scope of marketing or distribution, changes in the number of different types of products and demand of side changes such as marketing and distribution.

 An example is when the number of products promoted is increased and broader media used, more people can be reached with each dollar spent. However, diseconomies will occur as these efficiencies do not last and at some point additional advertising expenditure on new products will start to be less effective.

Advantages of economies of scale and scope occurs if a sales force is selling several products they can often do so efficiently than if they are selling only one product. The cost of their travel time is distributed over a greater revenue base, so cost efficiency improves. There can also be synergies between products such that offering a complete range of products gives the consumer a more desirable product offering than a single product would. It can also operate through distribution efficiencies and can be more efficient to ship a range of products to any given location than to ship a single type of product to that location. Sources of economies of scale and scope include:

Indivisibilities and spreading of fixed cost

For indivisibilities, input cannot be scaled down below a certain minimum size even when the output is very small neither will it increase as the output increases. This means it remains constant throughout no matter what the output is.

As for spreading of fixed costs, fixed costs are expenses that remains constant and do not vary with the level of output. This expenditure is shared among the departments of the organization. The greater the firm’s output, the more their overheads have to be spread. Like the concept of divisibility, fixed costs are “burdens” to the organization and they aim to keep them low. For the budget airlines, an alternative to keep their cost low is to sell air tickets on-line. This reduces cost by having lesser number of overheads and also increases the efficiency of the purchasing process as well as creating transparency in the pricing system.

Organizational Economies

Through merger and acquisitions, the organization gains advantages of having more talents and knowledge workers. Savings can be made through rationalizing whereby production will be reorganized so as to cut down on waste and duplication and its aim to cut down on cost.

 In order to keep the number of costly management pilots to a minimum, some airlines management introduced some retired pilots positions and hired non-flying simulators instructors. These savings will then be used to fund the increase in additional staff to provide better administrative support for the pilots. With the improved organizational structure and staffing, flight operation division is able to strengthen its safety management program, mount new initiatives and improve in communication with the pilots and implement programmed to enhance training and development.

R & D Economies

Research and development that are financed by big organizations will not only benefit itself but also others in the industry. By looking outside its own walls to stretch its research dollars, hotel management may spent about $1 Million a year (less than 1% of their IT budget) exploring on technologies like retinal scanners; finger prints readers as an alternative to the traditional key card for access to rooms. They are also experimenting on various wireless devices that connect to their reservation system. This handheld tool can be used to assist guests who have difficulties with the check-in-counters.

Inventories

Carrying inventories creates economies of scale because firms doing a high volume of business can usually maintain a lower ratio of inventory to sales while achieving a similar level of stockouts.

Specialization and division of labor

Specialization is the separation of tasks within a system. The specialization and concentration of the workers on their single subtasks often leads to greater skill and greater productivity on their particular subtasks than would be achieved by the same number of workers each carrying out the original broad task. Individual workers’ specialization is important as it enables the accomplishment of otherwise unatainable goals. Division of labor represents a qualitative increase in productivity. The advantages of division of labor are: it increases in skills & dexterity, time saving, individual aptitudes (can do what they are best at), use of machinery and managerial control. While disadvantages include: interdependency, dislocalisation (strike in one causes big losses), unemployment and alienation (no job satisfaction). Increasing specialization may also lead to workers with poorer overall skills and a lack of enthusiasm for their work. The workers become more and more specialized and work repetitious would eventually lead to boredom and complete alienation. As a result of division of labor, the worker is "reduced to the condition of a machine

 Multi-stage Production

It incorporates the material flow functions of receiving raw material or sub assemblies, manufacturing, distributing and delivering. It has many information processing and decisionmaking functions, reflected in the many information flow lines. And it includes funds handling functions because working capital in the form of payables and receivables are just as important as working capital in the form of inventory and equipment.

 Financial economies

Financial economies arise because the interest rate for getting a loan is higher for smaller firm that for larger one. This is because large firms have large assets and bank trusts them more. It is also relatively easier for large firms to raise their share-capital by issuing shares.

 Purchasing Economies

Purchasing in bulks offers benefits in discounted price such as less costly for a seller to sell to a single buyer, lower contract and negotiation costs, bulk buyers tend to be more price sensitive and sellers fear disruption if they lose the buyer. It can place small buyers at a disadvantage unless they cooperate. The larger the firm, the bigger chance of it being able to buy in bulk. This is the main factor associated with economies of scale. It occurs when large firms place consistently large orders with suppliers and so leaves them in control when negotiating terms.

Marketing economies

They are available both in purchases of raw material and in selling of the product. A large firm may have a bulk discount when purchasing raw materials. In terms of promotion, to large firms the average cost is smaller, because the prices of advertisements are the same for all firms.