Economies of Scale and Resource Mix

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This revision presentation looks at the operational issue of business scale. What are economies of scale and should a business adopt a capital or labour intensive business model?

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Economies of Scale and Resource Mix

  1. 1. Economies of Scale & Resource Mix
  2. 2. Unit costs formula Average cost per unit is calculated using this formula: Total production costs in period (£) Total output in period (units)
  3. 3. Economies of scale Arise when unit costs fall as output increases
  4. 4. Economies of scale illustrated Average Cost per Unit (£) Quantity of output Cost Curve AC1 AC2 Q1 Q2 Unit costs are falling as output increases from Q1 to Q2 = economies of scale Unit costs start to rise as output rises above Q3 = diseconomies of scale Q3
  5. 5. Minimum efficient scale The output at which average unit costs of production are at their minimum
  6. 6. Internal v External Economies of Scale Arise from the increased output of the business itself Internal Occur within an industry: i.e. all competitors benefit External
  7. 7. Internal economies of scale Buying economies Buying in greater quantities usually results in a lower price (bulk-buying) Technical Use of specialist equipment or processes to boost productivity Marketing Spreading a fixed marketing spend over a larger range of products, markets and customers Network Adding extra customers or users to a network that is already established (e.g. mobile phones) Financial Larger firms benefit from access to more and cheaper finance
  8. 8. External economies of scale <ul><li>Arise from the industry as a whole – i.e. all competitors benefit </li></ul><ul><li>Often associated with particular geographic areas </li></ul><ul><ul><li>E.g. Creative & media in London </li></ul></ul><ul><li>Examples </li></ul><ul><ul><li>Having many specialist suppliers close by </li></ul></ul><ul><ul><li>Access to research and development facilities </li></ul></ul><ul><ul><li>Pool of skilled labour to choose from </li></ul></ul>
  9. 9. Diseconomies of scale Factors which cause the average production cost per unit of a business to increase above the efficient level
  10. 10. Examples of diseconomies of scale <ul><li>Poor communication </li></ul><ul><li>More difficult to control a larger, more complex business </li></ul><ul><li>More frequent machinery & employee breakdown if output & capacity utilisation is too high </li></ul><ul><li>Loss of management focus </li></ul>
  11. 11. The resource mix What is the optimal mix of labour and capital in a business?
  12. 12. Labour versus Capital intensity Labour Intensive Production relies on using labour resources Capital Intensive Production relies on using capital resources
  13. 13. Examples of labour / capital intensive industries Labour intensive Capital intensive Food processing Oil extraction & refining Hotels & restaurants Car manufacturing Fruit farming Web hosting Hairdressing Intensive arable farming Coal mining Transport infrastructure
  14. 14. Implications of intensity Labour intensive Capital intensive Labour costs higher than capital costs Capital costs higher than labour costs Costs are mainly variable = lower breakeven output Costs are mainly fixed = higher breakeven output Firms benefit from access to sources of low-cost labour Firms benefit from access to low-cost, long-term financing
  15. 15. Benefits and drawbacks of capital intensive Benefits Drawbacks Greater opportunities for economies of scale Significant investment Potential for significantly better productivity Potential for loss competitiveness due to obsolescence Better quality & speed (depending on product) May generate resistance to change from labour force Lower labour costs
  16. 16. Benefits and drawbacks of labour intensive Benefits Drawbacks Unit costs may still be low in low-wage locations Greater risk of problems with employee/employer relationship Labour is a flexible resource – through multi-skilling and training Potentially high costs of labour turnover (recruitment etc) Labour at the heart of the production process – can help continuous improvement Need for continuous investment in training
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