Strategic Cost Dynamics

Strategic Cost Dynamics

Strategic Cost Dynamics covers three Economics concepts.

Economies of Scale Economies of Scope Learning by Doing

Economies of Scale

Economies of Scale

Economies of Scale exist when larger-scale facilities, optimally used, provide lower average unit cost.

AC = TC / Q

Internal Economies of Scale

Internal – advantages that arise as a result of the growth of the firm.

Technical Commercial Financial Managerial Risk Bearing

Internal = growth of the firm

External economies of scale External economies of scale – the advantages

firms can gain as a result of the growth of the industry – normally associated with a particular area

Supply of skilled labour Reputation Local knowledge and skills Infrastructure Training facilities

External = growth of

the Industry

Economies of Scale - Internal: Technical

Larger companies can afford bigger machines – which may produce more efficiently and do more tasks

More machines can mean less staff Machines can work 24/7 The larger the business the greater the number

of tasks that a piece of equipment will have to do.

Increased dimensions – bigger containers can reduce average cost

Bulk Buying Economies:Commercial

The larger the company the more it tends to buy in materials and components.

The larger the order the better the discounts and the less frequent deliveries also reduces delivery costs.

Supplier just uses a larger box/lorry rather than sending in lots of small packages.

Managerial Economies

The larger the company, the more specialized each manager can become.

In a small business, there is usually only one manager who has to do everything.

In a large business, there is a larger span of control, with specialist managers for each department.

Use of specialists – accountants, marketing, lawyers, production, human resources, etc

Financial Economies of Scale

The smaller the business, the greater the risk for a bank to lend you money.

The larger the business, the less of a risk – due to experience, more products, greater diversification, better specialist accounting managers.

Large firms able to negotiate cheaper finance deals

Risk Bearing

Greater Diversification Markets across

regions/countries Product ranges R&D

Economies of Scale

Unit Cost

Output

Scale A

Scale B

LRAC

MES

82p

54p

The larger the output the

lower the cost per unit!

Economy of Scope

Economy of scope occurs when there are benefits to combining the production of two or more products.

If a single firm can jointly produce goods X and Y more cheaply that any combination of firms could produce them separately, then the production of X and Y is characterized by economies of scope

Economy of Scope

Economies of scope arise from “complementarities” in the production or distribution of

distinct goods or services

Real world examples

Economies of scope between cable TV and high speed internet service.

Production of timber and particle board. Power generation and distribution. Joint cargo and passenger

transportation in airlines reduces excess capacity.

Global wholesale distribution of cheese, salad dressing, and cigarettes.

Learning By Doing

Average costs tend to fall as an organization gains experience with the manufacture of an object. The effect is called learning by doing.

Learning-by-doing is largely the result of improvements in methods and processes.

Learning By Doing

By: Vivek Kumar