Economies of Scale
Economies of scale have been defined concisely as advantages resulting purely from size (1989) and have been studied extensively (1982; 1971; 1975).
Further, scale economies have been categorized by source, identified seven of them: cost indivisibilities, economies of increased dimensions, economies of specialization, superior techniques or organization of production, the learning effect, economies through control of markets, and economies of massed resources which is also known as statistical economies of scale (1971).
According to (2003), economies of scale are achieved when more units of a good or a service can be produced on a larger scale, yet with (on average) less input costs. Alternatively, this means that as a company grows and production units increase, a company will have a better chance to decrease its costs. According to theory, economic growth may be achieved when economies of scale are realized.
While cost reduction efforts appear to be extremely popular among companies attempting to strengthen their competitive position, the effect of traditional cost reduction strategies on company productivity is less clear, and may in some cases be detrimental to long-term financial performance.
Particularly during times of economic recession, it is important for companies to identify cost-reduction strategies that create long-term benefits for the company. It is hypothesized that reducing unit costs through the use of volume and learning economies of scale can provide significant productivity benefits to a company, provided policies regarding flexibility and innovation do not create barriers to strategy implementation.
The importance placed on increasing company productivity has gained considerable momentum in recent years as companies struggle to keep pace with increased competitiveness and consumers' increasing awareness of product quality. Since company productivity is generally defined as a ratio of output to input (for example, revenues divided by costs) management strategies for improving productivity have usually included some form of cost-reduction effort.
While many of these efforts are necessary and indeed enhance company productivity, some cost reduction strategies actually reduce the company's ability to be less able to provide customer service, to react quickly to changes in customer tastes, to maintain an innovative approach to process/product design and marketing and to simply maintain product output levels at some adequate level of quality.
Learning economies of scale are created when technical knowledge gained through company experience permits changes to be made to existing plant, equipment and labor, leading to better and more efficient use of existing resources. The learning effect is the term used to represent this impact of technical innovation on the cost function of the company. In this context, technical innovation is referred to as the implementation of any value-enhancing techniques to the transformation process of the company (examples include supply-base reduction, storage consolidation, use of shop floor control policies, group technology plant layout changes and just-in-time production techniques).
Extensive research indicates that as the cumulative output of a product doubles, the real, value-added unit cost of manufacturing that product tends to be reduced by a constant percentage.
Learning economies of scale include labor and organizational production and planning advancements that accrue with time throughout the company's transformation process. (1964) describes three types of learning economies:
Ø labor improvements in the performance of tasks;
Ø improvements in managerial planning and control; and
Ø product and process innovations that reduce unit costs or increase value
There are two aspects of economies of scale. Economies of scale that appear at the aggregate level are described as external economies while economies of scale that appear at the individual or firm level are called internal economies of scale which the focus of this paper.
There are some types of internal economies of scale which includes technical, commercial, managerial, and risk bearing. Internal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself.
Technical economies are when businesses are able to benefit from improved techniques involved with large scale production. For example, a company like Gillette or BIC operates with very large modern factories using automated production technology. The result of using these technologies is that costs of production are reduced significantly while quality control is kept to a very high level with virtually zero defects.
Similarly, electronic and electrical goods industry can also acquire such modern and automated production technology. Technical improvements include simultaneous product and process design, setup time and batch size reduction efforts, automated group technology layouts and new product designs that use part commonalities to reduce design costs and improve manufacturing quality.
In addition, commercial economies are concerned with the purchase of stocks and the selling of end products using a large scale approach. Modern production plants are able to operate using components and materials that are purchased just-in-time for their use. The production line is managed at the speed required to meet the needs of end consumers just-in-time.
Electronic/electricity goods industry can use mass production techniques in which they are able to operate their plant at high levels of capacity, while benefiting from bulk purchasing of components, equipment and materials.
Moreover, managerial economies of scale involve these firms in employing skilled production managers with the experience of working with modern technologies enabling them to manage highly sophisticated state-of-the-art factories. As a firm grows, there is greater potential for managers to specialize in particular tasks such as marketing, human resource management, finance. Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles.
In the case of the electronic/electrical goods industry, these companies should employ specialist on the field of marketing, human resource management or finance.
Management improvements used in many electronic/electricity goods companies include fewer levels of management with greater decision-making authority given to line workers and shop floor managers and new systems of control, such as total preventive maintenance and total quality control programs that improve company performance. These companies should place a great deal of emphasis on employee skills development through extensive training programs. Fewer job classifications and multi-functional employees contribute to productivity improvements and enhanced labor flexibility.
Furthermore, risks spreading economies of production mean that plants are able to produce a wide variety of products. For example, in a modern confectionery plant run by Cadbury Schweppes, it is possible to switch part of factory capacity from lines where demand is falling, to lines where demand is rising through well organized production management. Similarly, electronic/electricity goods industry must be able to identify their risks and appropriately mitigate them to avoid more damage to company.
Disadvantages of Economies of Scale on Consumers
However, in spite of numerous advantages which economies of scale have mentioned, there are still disadvantages. The first disadvantage would be that the products of the same type could virtually all be the same. Consumers would be hard pressed to find unique items either for gifts, personal pleasure or to fulfill a unique need.
A second and related is that the possible low cost of such mass-produced items might diminish the market for new and competing items. Eventually, this could lead to a virtual monopoly on some products, which may lead to higher future costs and even less innovation in that area.
Moreover, according to (1999), “the disadvantages to the customers is clear cut.” He commented that the greater the imbalance of the power between seller and buyer, the less responsive the market will be with the demand. For example, when a company has one hundred customers, it listens carefully to what each of them wants. However, when it has one million, it responds to the lowest common denominator (1999).
Inappropriateness of Economies of Scale
According to (2003), the theory of economies of scale was set off by the British economist which includes and . These economists had suggested that larger companies would have likely to achieve economies of scale due to greater opportunities for division of labor.
Technically, a scale curve measures production costs as a function of facility capacity (2003). Plotted on a logarithmic scale, the slope of the curve shows the fixed percentage reduction in cost for each doubling of capacity. Businesses with operations that offer significant economies of scale, such as wafer fabrication for integrated circuits, have steep scale curves where costs drop significantly when facility capacity increases which is why the Intel Corporation and other chip makers regularly invest upward of a billion dollars in new higher-capacity facilities.
However, other businesses, such as apparel-producing plants, exhibit very limited scale economies. Since there is little opportunity to automate the process of sewing a dress or shirt, a larger apparel plant simply contains more sewing machines. A plant with 200 sewing machines run by individual operators doesn’t produce shirts and dresses much more cheaply than one with only 100 machines. There is little value in having a bigger apparel factory.
Firms achieve economies of scale when their operating costs increase at a lower rate than their output. In manufacturing operations, plant volumes must reach a certain minimum level for a firm to achieve economies of scale. In industries, such as aircraft, automobile, chemical production and petroleum refining, plant volumes needed to achieve economies of scale are so high that only a few firms can attain them without foreign sales (1990).
(1989) suggests that multinational service firms, like manufacturing firms, can benefit from global economies of scale in personnel specialization, financial management, and common governance. (1994) propose that service firms can achieve global economies of scale in marketing or image-building. Furthermore, (1996) theorize that information-based service firms, such as insurers, can achieve global economies of scale by providing global customers with standardized insurance products and by centralizing upstream value chain activities.
However, firms still incur fixed costs in their operations that do not increase with output. For example, computer systems and software cost the same whether they process ten or ten thousand dollars in premiums each day.
In addition, with the response to opportunities in the foreign market and globalization, there has been increasing number of companies expanding internationally. Most of these companies believe that only very large firms will have economies of scale to remain competitive. However, expanding internationally may offset the advantages of economies of scale by the higher costs of foreign operations. Buckley and (1976), and (1981), commented that costs for firms in the foreign markets may be higher than in home markets.
Moreover, as firms increase their size through internationalization, they increase the complexity of their operations and the cost of coordinating those operations. This may cause diseconomies as scale increases (1985). In addition, a firm must manage all aspects of its value chain and the interaction between them to achieve low costs ( 1985). The firm must take care that actions in one area do not create barriers to economies of scale in another area (1985). For example, geographic differentiation as opposed to concentration of activities and product differentiation as opposed to standardization, while creating market advantages, may hinder economies of scale in services (1996).
Minimum Efficient Scale
Minimum efficient scale is the output for a business in the long run where the internal economies of scale have been fully exploited. It corresponds to the lowest point on the long run average total cost curve. The minimum efficient scale varies from industry to industry depending on the nature of cost structure in a particular sector of the economy. When the ration of fixed to variable costs is very high, there is a great potential for reducing the average cost of production.
In industries with monopolistic bottlenecks, like network industries, the question arises whether and how to regulate these essential facilities. Electronic and electricity goods are vital for the health of the European economy. This industry increases productivity throughout the economy, generates new consumer services and creates jobs for the European work force.
In connection with this, (2005) points out the importance to establish regulation right after liberalizing the market. Nevertheless, by designing the regulation authority it is important to keep in mind whether regulation serves as a precondition of competition or rather as a substitute of competition. If regulation is a precondition and the final goal is the competitive market, one should probably strive in the very long run for replacing sector regulation by general competition rules.
Based on the experience, policy makers believe that extending competition and ensuring opportunity and reward for innovative companies is the key to promoting technological advance.
Generally, the difficulty of the regulatory authorities has originated in state-run monopolies, leaving a legacy of imperfect competitive conditions. Continued regulation is therefore essential for as long as these former monopolists have market power, to ensure a level playing field for new market entrants.
In addition, another reason is that market forces alone may lead to the exclusion of some social groups from essential public services. The regulatory system therefore recognizes a universal service obligation to ensure basic services at affordable prices to all in cases where the market alone does not provide.
Regulatory authorities has pursued it s regulation on competition in order to regulate the state run monopoly which has been happening as experienced. A general authorization procedure for operators to enter new markets replaces individual licenses. This drastically cuts red tape for enterprises, which no longer face frustrating delays as national regulators check compliance with license conditions.
In addition the regulators applies light regulations which is the framework that builds upon general concepts of competition law, as applied to normally functioning markets.
Regulation is seen as essentially a temporary phenomenon, required to make the transition from the monopolistic industry to a fully functioning market system. To develop in the short term, new market entrants need regulatory support to gain access to the networks of incumbent operators and to provide the benefits to end users which the market would offer if it were effectively competitive.
However, as the sector evolves, operators will increasingly build their own infrastructures and compete more effectively. As normal market conditions develop, regulation can be rolled back, and competition law, as applied to industry in general, will replace sector-specific intervention.
Moreover the regulatory authorities are concerned with the technological authorities. The primary principle is to apply the same principles regardless of which kind of existing or potentially new technology is involved. This “technological neutrality” is essential to provide the necessary flexibility to deal with emerging technologies and their convergence in fields such as media, internet and mobile communications.
Furthermore, concerns are also pointed to the consistency in the market. Operators need to be assured that their investments can be planned in a regulatory environment that is stable, consistent and predictable throughout the market. Such a regime allows companies to operate on a scale.
The regulatory framework establishes new processes permitting collaboration among the national regulatory authorities of the Member States and between national authorities and the Commission. This extensive collaboration plays a key role in achieving the necessary coherence within the regulatory process at European level. In key areas, each Member State submits its draft national measures to the Commission and to other national authorities for consideration, and discusses common approaches in the European Regulators Group, established by the Commission in 2002. In this way, a consistent approach is developed throughout the single market while permitting maximum flexibility to deal with national markets and conditions.
The framework explicitly recognizes the need for regulators to allow adequate cost recovery on existing assets, and to properly reward innovation and new, risky investments.
Regulatory intervention is required for a variety of reasons. Regulatory intervention is required in the success of the transformation of a monopolistic market into a competitive market. Without it, viable competition is not likely to emerge. Typically, regulators must authorize or license new operators. They must remove the barriers to market entry of new operators. In addition, regulators may also be required to ensure competitive markets do not fail to serve high cost areas or low income subscribers. Where competitive markets do not exist or fail, there would be abuses of market power such as pricing and anti-competitive behavior by dominant firms.
Primarily the main objectives of the regulators is to foster competitive markets to promote efficient supply of goods and services, supply of good quality of goods and services, and efficient prices.
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