Horizontal Boundaries of the Firm: Economies of Scale and Scope Chapter 2. Economies of Scale and Scope. Economies of Scale. The concept of economies of scale provides the primary connection between technology and firm competitive strategy.
Economies of Scale and Scope
Economies of Scale
The concept of economies of scale provides the
primary connection between technology and firm competitive strategy
Numerous definitions, but the most useful seems
to be: Economies of scale exist when average cost is declining.
Important to distinguish between long-run and short-run notions of economies of scale.
Minimum Efficient Scale
Long-run: shape of the average cost curves dictated by existing state of knowledge.
Minimum Efficient Scale
Short-run: technology (quasi-) fixed and embodied in plant and capital investment (e.g. business design)
Long-run economies of scale impact industry structure and are only relevant in the pre-entry stage.
Short-run economies of scale, affect operating decisions and are relevant to post-entry stage
Economies of scope exist when there are cost savings associated with a broadening of a firm’s scope of activities.
Increases in the number of products or services produced
Formally, economies of scope exist if:
C(Y1,Y2) < C(Y1,0) + C(0,Y2)
In essence, joint production is less costly than production of single product lines
Indivisibilities and fixed-cost Spreading
Increased productivity of variable inputs (specialization
The cube-square rule
Spreading of product-specific costs
Trade-offs among alternative technologies
Indivisibilities more likely with capital intensive
The division of labor is limited by the extent of the market
Scale Advantage and Capacity Utilization
Efficiency gains via specialization of function?
Cost of inventory management can decline with size of firm
Smaller inventory as a percentage of total sales
Cube Square Rule (2A3)
Ratio of surface area to volume declines geometrically
Can convey technical economies in distribution and storage
Spreading of marketing and advertising costs
Research and development costs
Complementarities and Strategic Fit
Labor Costs and Firm Size
Incentive and bureaucracy costs
Spreading of specialized resources
Utilization of excess capacity (especially in the presence of indvisibilities)
Utilization of fixed marketing/retailing costs/infrastructure
Exploitation of reputation and brand identity
Common terms used in (implicitly) discussing economies
of scope include:
Leveraging core competencies
Competing on capabilities
Learning Curves account for the cost advantages associated
with experience and know-how
Can occur at the individual level
Can occur at the organizational level
Learning curve advantages can be manifest in:
Efficient pricing or competition policies
Measures the decline in average cost when cumulative output is doubled.
PR = AC1/AC2
Median for U.S. is about 0.80, which implies a reduction in unit cost of 20% for each doubling of cumulative output.