Operational Optimum Size: Explanation of Its Functioning
In the world of business, economies of scale play a crucial role in determining a company's profitability and competitiveness. Economies of scale refer to cost savings that result from producing larger quantities of a product, due to factors such as specialization and division of labour, technological advancements, bulk purchasing, learning curve effects, marketing and distribution efficiencies, and external economies of scale.
The minimum efficient scale (MES) is a significant concept in this context. It indicates the range of outputs where a business is achieving productive efficiency. This point is essential as it serves as a limit for deciding whether to increase output or not. For instance, a company operating within the MES output range can benefit from lower unit costs due to optimal technology, capital, factory capacity, and labour.
The MES is also an important indicator of entry barriers. In a perfectly competitive market, all companies operate at the MES because the long-run price equals the minimum average cost. However, a high MES can serve as an obstacle for newcomers, making it challenging for them to produce larger quantities to achieve economies of scale, due to the need for heavy investment in production facilities.
However, beyond the MES, diseconomies of scale may emerge. These occur because huge factories create many overlapping jobs, and when buying large quantities continuously, resources become scarce, raising the price. As a result, costs per unit start increasing, which can negatively impact a company's profitability.
The term 'economies of scope' refers to cost savings that result from producing multiple products with shared inputs or resources, rather than producing each product separately. The calculation of economies of scope involves comparing the total cost of producing multiple products separately to the total cost of producing them together, taking into account the shared inputs or resources.
In conclusion, understanding economies of scale is essential for businesses, particularly small manufacturers, to make informed decisions about production levels, technology investments, and market entry. By leveraging economies of scale, companies can reduce their average costs, improve productivity, and ultimately, enhance their competitiveness in the market.
- In the realm of industry, strategically planning operations within the minimum efficient scale (MES) can provide a company with lower unit costs, allowing them to benefit from optimal technology, capital, factory capacity, and labour.
- Beyond the MES, finance managers must be wary of diseases of scale, as these can arise when huge factories create numerous overlapping jobs and resource scarcity increases, leading to a rise in costs per unit, impacting profitability negatively.
