ECONOMIES OF SCALE

Economies of scale refer to economic efficiencies that result from carrying out a process (such as production or sales) on a larger and larger scale. The resulting economic efficiencies are usually measured in terms of the unit costs incurred as the volume of the relevant operation increases. "Scale economies can be present in nearly every function of a business, including manufacturing, purchasing, research and development, marketing, service network, sales force utilization, and distribution," wrote Michael E. Porter, author of Competitive Strategy. "Scale economies may relate to an entirely functional area, as in the case of a sales force, or they may stem from particular operations or activities that are part of a functional area."

Many small business operations are of insufficient size to utilize economies of scale to major strategic advantage, though there are instances in which even smaller businesses can use such economic efficiencies to gain an edge over startup competitors. Indeed, John Pearson and Joel Wisner noted in Industrial Management that "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," of which economies of scale is often an essential element. In other words, even the smallest company can make itself healthier by improving its economy of scale. In competitive terms, however, small businesses often find that economies of scale are most visible as a weapon utilized by their larger competitors as a barrier to market entry.

As noted above, the concept of economies of scale has been used in a wide range of business operations, including sales and marketing, Most often, however, discussions of economies of scale have centered around manufacturing, equipment, and facility management areas. Howard J. Weiss and Mark E. Gershon, authors of Production and Operations Management, separated economies of scale into two types—construction and operations. "The construction economy of scale is that construction costs rise less than proportionately to building size," they wrote. The operating economy of scale, meanwhile, is based on the idea that "for any given facility size, there is an optimal operating level that minimizes the cost per unit…. Consider the fact that two plants will require a duplication of resources, whereas one large plant may not. This is the operating economy of scale."

But researchers have also distinguished economies of scale by other criteria. Pearson and Wisner separated economies of scale into "learning" and "volume" segments. "Learning economies of scale include labor and organizational production and planning advancements that accrue with time throughout the company's transformation process," they explained. "A company's learning curve provides an opportunity to identify and forecast supply costs, transformation costs, and finished product costs. Learning curves identify the rate a business has historically reduced the real, value-added, per-unit cost of its products. The ability of a company to continue this cost-reduction trend gives an indication of the adequacy of existing production cost-cutting or value-enhancing procedures and proposals. If a company connot continue to cut product costs or increase value sufficiently over the long run while maintaining satisfactory levels of quality, it stands a good chance of being priced out of the industry by competitors."

Volume economies of scale, meanwhile, are described by Pearson and Wisner as episodes wherein increases in product capacity produce lower unit costs by making additions to plant, equipment, labor force, or other facilities. While these additions to capacity generally produce upturns in fixed costs, these added production expenses are covered by improvements in per unit costs.

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