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Terms Average cost – Average cost we take as average total cost per unit = fixed cost plus variable cost divided by output Economies of scale – A fall in average costs as output rises Diseconomies of scale – Average costs increase as output increases DoS

Technical economies of scale Technical economies. This is probably where the theory started, and come typically in production processes. There are at least 2 sources. First, a machine is indivisible (cannot have half a machine) – It is at its most efficient when it is used all the time. Imagine in a car plant a pressing machine which could press 100 sheets an hour, each of which is the roof of a car. To be used all the time, 365 days a year 24 hours a day, you would want to be producing almost 900,000 cars a year. – A cement mixer can mix cement for 24 hours, but if it is used for 1 job a week, then the cost is more per job (unit) than if it is used 7 days a week Second, law of dimensions – Particularly for transport, the cost of transport rises more slowly than the volume transported. For example a ship double the length can carry up to 8 times the volume (length is double, area is square and volume is cubed so 2 x 2 x 2). But the cost of operating is not 8 times – eg perhaps 50% more staff Also, and related to this, larger companies can afford the most up to date and efficient machinery, or say computer systems

Specialisation economies of scale Managerial economies. Start up company will have a single person who is expert at everything – HR, production, Marketing, finance. Don’t think so. As a company expands it can hire experts. A school can have specialists in various posts. Also company only needs 1 boss and 1 board, Tesco is larger than Sainsburys, but probably has a similar sized management Also labour specialisation. Good example from building, all round builder to specialists who are brickies, sparkies, plumbers plasterers etc

Purchasing economies of scale Purchasing power. Can Tesco buy food and other goods more cheaply than an independent local shop. You bet. Why? Large order is good business for many suppliers. A guarantee of large orders is worth a lower price – at least volumes will be large Since Tesco buys a larger amount this is also cheaper for suppliers who can produce bulk amounts more cheaply (their own economies of scale) Therefore Tesco buys food/raw materials at a lower price than smaller firms

Other economies of scale Financial economies of scale – Bigger companies can borrow more easily and cheaply from banks. – Banks are still suffering after the financial crisis, with barely adequate reserves, and so are less willing to take risks in lending. This means Smaller firms may not be able to borrow (banks are more willing to lend to firms with track records = big ones) Smaller firms will pay higher interest rates to compensate for the increased risk banks take lending to them – Bigger firms have better access to capital markets like the stock exchange and so can sell shares more easily (because they can list, or are already listed on a stock exchange) Marketing economies of scale – Advertising can be thought of as a fixed cost, so larger companies can spread the cost of advertising over greater output – Tesco advertises about the same as Sainsbury’s but is much larger, so cost per unit is lower

Diseconomies of scale Not so easy to pin down Cannot easily see technical diseconomies – a firm could surely duplicate a plant Typically, diseconomies come from management, with larger management structures CEO Director General Manager Director General Manager

Diseconomies of scale Generally think of 3 main categories of diseconomies Communication suffers – As the business expands communicating between different departments and along the chain of command becomes more difficult. There are more layers in the hierarchy that can distort a message and wider spans of control for managers. This may result in workers having less clear instructions from management about what they are supposed to do when – In addition, there may be more written forms of communication (eg newsletters, notice boards, s) and less face-to-face meetings, which can result in less feedback and therefore less effective communication.

Diseconomies of scale Coordination harder – It is harder to ensure that all workers are working for the same overall goal as the business grows. It is more difficult for managers to supervise their subordinates and check that everyone is working together effectively, as the spans of control have widened. A manager may be forced to delegate more tasks, which while often motivating for his subordinates, leaves the manager less in control – For example, a small manufacturer can more easily co-ordinate the activities of its small number of staff than a large manufacturer employing tens of thousands. Motivation falls – Workers can often feel more isolated and less appreciated in a larger business and so their loyalty and motivation may diminish. It is harder for managers to stay in day-to-day contact with workers and build up a good team environment and sense of belonging. This can lead to lower employee motivation with damaging consequences for output and quality. The main result of poor employee motivation is falling productivity levels and an increase in average labour costs per unit