Economies of scale are the cost advantages that a firm obtains due to expansion. Economies of scale refers to the decreased per unit cost as output increases. The initial investment of capital is spread over an increasing number of units of output, and therefore, the marginal cost of producing a good or service decreases as production increases.
When applied on the factory floor, this tends to increase cost throughout the plant. In Economics, you are taught that “an increase in a firm’s scale of production leads to lower cost per unit”. This maybe correct, when you are looking at total output of the firm. Total output quantity divided by total cost equals average cost. This works, when looking at the firm as a whole. When this concept is miss-applied, firms try to apply this thinking to individual production areas. This kind of thinking raises cost throughout production. I have watch individual production lines run as hard as possible, for machine efficiency while building mounds of inventory (or cash) waiting in stock piles! Remember, economics of scale is only valid if the firm’s total out is increased. Many American organizations are working to achieve the benefits of economics of scale, while countering forces of diseconomies of scale are holding the firm back. The most often cited example of diseconomy of scale is bureaucratic inefficiency. As size increases beyond a certain point, operations tend to become more difficult to manage.
As this continues, production cost rises and inefficiencies expand throughout organizations – making the firm less competitive in the open market place. The firm will have choices, become lean or outsource/ offshore their production! Lean is a tougher journey and is better for local communities. American manufacturers’ will continue face this competitive pressure, the firm must make tough decisions.
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Saturday, May 31, 2008
Miss leading truths about Economics of Scale
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