What are the advantages and disadvantages to a firm of operating on a large scale?
Economies of scale fall under microeconomics and are the cost advantages a business obtains due to expansion. As scale is increased they cause a producers average cost per unit to fall. Microeconomics (from Greek prefix micro- meaning “small” and “economics”) is a branch of economics in which you study the behaviour of how the individual firms make decisions to allocate limited resources. Normally, it applies to markets where goods or services are being bought and sold.
Microeconomics examines looks at how these decisions affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the amount supplied and quantity demanded of goods and services. Scale means big, large, massive etc. And as such gives us a clue to the nature of this topic. An economy of scale is a range of factors that can benefit large firms and allow them to have some competitive edge over their smaller rivals, and is not just about buying in bulk.
In the following essay I will be exploring the advantages and disadvantages to firms of them operating on a large scale. Economies of scale occur when mass-producing a product results in a lower average cost. They can occur within a firm (internal) or within an industry (external). Internal economies of scale can be found in a firm as a consequence of mass-production. As firms produce more and more goods the average cost of the product begins to fall because of the following; technical economies created in production of the good e. . it will most likely be cost-effective to invest in more advanced production machinery, IT and software when operating on a larger scale as these resources can be used intensively. Also specialisation when working in a large workforce, the firm is likely to divide up the work and recruit people whose skills very closely match the requirements of the job e. g. specialist accountants and other workers to make sure they are maximising their profits and minimising any losses.
Some specialist machines are Indivisible as they cannot be broken down to do smaller jobs firms using more than one machine of different capacities are usually more efficient. Furthermore managerial economies form in the administration of a large firm by managerial positions being split and employing specialist salesmen, accountants, lawyers, production, and human resources. Larger firms can afford to have specialist managers for different functions within a business also they may be able to pay them higher salaries required to attract the best people for the job, leading to bettering the firm.
A wider range of finance options are available to larger firms, such as the stock market, bonds and other kinds of bank lending also a larger firm is likely to be seen by banks as a lower risk as apposed to a small firm and the cost of borrowing is likely to be lower for the firm. A lower interest rate in comparison to smaller firms is what leads to financial economies, as large firms can usually negotiate cheaper finance deals. Marketing economies are created when high costs of advertising on television and in national newspapers, across a large level of production.
This sort of advertising would not be cost effective for smaller firms, larger forms are also more likely to already have a good reputation which leads to people putting their trust in them rather than smaller firms. Commercial economies are made when buying supplies in bulk and therefore usually gaining a larger discount. Large firms can negotiate favourable prices which lead to them being able to sell at lower prices which are likely to increase their customer base as apposed to smaller firms.
However larger firms have advantages in keeping prices higher because of their market power. Research and development economies are made when developing new and better products. A larger firm can be safer from the risk of failure as it has a more diversified product range. Moreover larger firm may have greater resilience in the case of a downturn in its market because of larger reserves and greater possibility to make cutbacks. External economies of scale are economies made outside a firm as a result of location. They come about when a local skilled labour force is available.
Furthermore when specialist local back-up firms can supply parts or services. They can also come about because of a particular area having a good transport network; also if an area has an outstanding reputation for producing a certain type of good e. g. Sheffield is associated with steel. Indivisibility of Plant is when a machine can not be made to do more than the one particular job it is there for and is not viable to produce other products. Agricultural machinery appropriate for large scale work can be looked at under the principle of Multiples e. g. ome production processes need more than one machine to create an end product or just to be fully efficient. Internal diseconomies of scale transpire when firms become too large and inefficient. As the firm increases production eventually the average costs begin to rise. The disadvantages of the division of labour take effect and the management become out of touch with the shop floor and some machinery becomes over-manned. Decisions are not made quickly and there is too much form filling. The lack of communication in a large firm means that management tasks sometimes get done twice.
Poor labour relations can develop in large companies. These are inadequacies that can creep in when a firm operates on a larger scale such as lack of motivation in larger firms where workers can feel that they are not appreciated or valued as individuals. It can be more difficult for managers in larger firms to develop the right kind of relationship with workers. If motivation falls, productivity may fall leading to inefficiencies. It is easier for smaller firms to communicate with all staff in a personal way and develop good relations.
In larger firms there will probably not be much actually talking between staff and managers as there is likely to be a greater use of written notes rather than explanations from the managers. Messages can remain unread or misunderstood and staff is not properly informed because of this. Large businesses take a lot of organising, leading to an increase in meetings and planning to ensure that all staff know what they are supposed to be doing as in some cases the same work may be done twice as there is not much communication between managers and workers.
New layers of management may be required to defeat some problems but could lead to more as more management means more people need to be notified of changes and they might not all agree on the same things also this further adds to costs. The disadvantages of large scale production that can lead to increasing average costs are problems in the management maintaining effective communication and effectively co-ordinating activities often across the globe. Staff De-motivation and alienation can often be a problem within large firms due to lack of communication.
External diseconomies are when thee are too many firms situated in one area offering similar or the same services. Unit costs will begin to rise because local labour becomes limited and firms may have to offer higher wages to attract new workers. Moreover land and factories become scarce and rents begin to rise making it harder for firms. Also as the local transport network becomes more congested the transport costs will begin to rise eating in to any profits.
In conclusion, is bigger better than smaller? Many firms strive to grow at least partly because of the economies of scale they could enjoy. The increased efficiency from economies of scale is very compelling in many industries. Another reason is that they may be able to enjoy market power, with more control over suppliers and customers. Still another reason is the perceived success of the business simply because of its growth – this can be especially important for a stock exchange listed company.
Diseconomies of scale do not have to happen as a business becomes larger. Effective management and organisation can minimise these effects and help to ensure that the benefits of increased size outweigh any disadvantages. Management approaches to organisational structure and motivation show how a firm could overcome diseconomies of scale. Smaller firms are not necessarily at a disadvantage in all markets. In some markets, economies of scale are not available or not convincing enough for large firms to dominate.
This is often the case with small local businesses, such as hairdressers and plumbers. Furthermore, small businesses can succeed simply by identifying a niche market and by serving it really well. Smaller firms can be more flexible and may be able to adapt quickly to changes in their markets or in the economy. In my personal opinion I believe there are more advantages to firms operating on a large scale than disadvantages. Bibliography “Elementary Economics”, by Charles Manfred Thompson www. tutor2u. net www. bized. co. uk