Economies Of Scale Essay

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Economies of scale refers to reduction  in unit costs associated with producing large volumes of a product. Reductions in cost in this manner arise in a number of ways. First, by producing in volume, more of the fixed costs involved can be distributed  over a larger number of final products.  Then, too, large-scale producers can take advantage of specialized equipment  and manpower that are highly productive due to increasing returns  of specialization. Economies of scale play a critical role in global business today, with respect to government policy, regional integration, and business strategy. It is a central  component of strategic trade policy (otherwise  known  as the  new trade  theory) and in the strategic profiles of multinational firms. A growing concern  for multinationals is the increasing difficulties implementing  economies  of scale strategies in the 21st century.

The origins of economies-of-scale  production can be traced to the early phases of the industrial revolution in the United States, and particularly in the second half of the 19th century. The ability to efficiently turn out products in large volumes was in part due to the growing pool of labor-saving machines designed and built by American  inventors  and machinists.  A turning  point in this progression  was the shift from batch and semi-continuous production to fully continuous operations. The moving assembly line and the division of labor into specialized tasks carried out at specific workstations along that line to produce standardized  products  was a culmination  point  in this effort to place production on an economies-of-scale basis. The automotive industry—and Ford Motor Co. in particular—spearheaded this mass production revolution. Other  industries  soon adopted  the technology in its various incarnations  suitable to the particularities of their production processes.

Achieving economies of scale in production depended also on seamlessly integrating these machines  and systems into the organizational  fabric of the factory and ultimately the corporate  structure as a whole. The close structural  interlink ages formed between corporate  divisions through  managerial and organizational  innovations  by the  third  decade  of the 20th century  assured  a smooth  and timely flow of materials and components upstream into the plant and  the  readiness  of the  distribution   network  and market demand at the appropriate  time downstream. All this contributed to a steady high-volume  output of final product   and  the  essential  economies  that attended large-scale production.

Since  the  1980s, economies-of-scale  production has diffused into many industries, including electronics and information  technology. Economies of scale are also an important force in the  evolution  of the European Union and the rise of the “Single Market.” The fact that much of Western  Europe is a monetary union,  for example, leads to  economies  of scale in financial markets  and, in turn,  greater availability of cheaper capital for multinationals.

Global Strategies

Economies of scale play an important role in global business strategy. Supporters  of neomercantilist policies stress  that  governments  that  support  certain  industries,  especially those  burdened  by high capital costs—which can include high research and development  (R&D) costs—to  achieve  first-mover advantage in global markets  actually produce  a net positive  impact   for  all  countries.   Such  strategic trade policy is relevant in high–fixed cost industries, such as aircraft  production,  in which total  market demand  globally is limited  and  can  support  only one  or  two multinational companies  (MNCs)  efficiently. Government  subsidies to these companies, including tax incentives, R&D support, and so forth, allow them  to take early control  of global markets. This assures them  that  they serve sufficiently large demand  to produce  in volume and, through  economies of scale, at reduced  costs. In turn,  the market receives a greater variety of products  at low prices. But government  support  is by no means a sine qua non of achieving such first-mover advantage.

An MNC that, through  its own resources, attains economies-of-scale  production can  take  control  of global markets  through  appropriate   pricing  strategies. From the 1930s through the 1960s, the U.S. petrochemical industry proved particularly adept in this sort of strategy. They rapidly scaled up production of new products  discovered in their R&D departments, thereby quickly securing a lock on markets within the United States and internationally.  When competition eventually filters in—as it did in petrochemicals  in the 1970s and aircraft production in the 1980s—the market  becomes segmented  and the minimum  output  required  for the  benefits of economies  of scale to kick in cannot  be achieved within any competing company.  Inefficiencies then  infect  the  industry  as a whole, profits erode, and economic  activity in the industry as a whole contracts.

The appropriate  strategy  to  be taken  by a multinational firm in increasingly globalized markets depends to a large extent on the degree of cost pressures it faces relative to pressures to be locally responsive. A specific type of strategy that is most effective in negotiating  cost pressures  is often referred  to as a “global” strategy. These pressures  can arise from companies  having to bear high costs of production (fixed costs,  R&D, etc.),  face  stiff competition in strategic  markets,  or both.  At the same time, such MNCs make, sell, or distribute  standardized,  commodity  products—e.g., bulk chemicals, petroleum, steel, sugar, and many industrial and consumer products—or  services that  have  a universal  need, and  therefore  are not  concerned  with  redesigning products  for different local markets. In these situations, MNCs can take full advantage of economies of scale by building and operating of a few large plants designed  along mass production lines and  located in strategically sensitive positions—near critical raw materials,  central  to its markets,  optimal  access to suppliers  and  subcontractors,  and  so  on—around the world. Further, global industries that rely extensively on  economies-of-scale  strategies  tend  to  be more  difficult for outside  firms to enter  due to the high capital costs involved.

Transnational Strategies

In fact, most MNCs must realistically consider both cost and local pressures  when devising and carrying out their business strategies. Differences in customer tastes and preferences, traditions  and beliefs, infrastructure and distribution  channels,  and laws, regulations, and standards  between countries  compel MNCs  to adjust—or  customize—products and services to the specific requirements of local demand and conditions; at the same time, they must compete in both quality and price. The type of business strategy that must balance and coordinate these two types of pressures is called a “transnational” strategy.

Since an  “economies of scale” or  “global” strategy depends  on the  mass production of standardized products  and  services, and  since  a “localization” (otherwise known as “multidomestic”) strategy functions  by custom-designing products  and  services for smaller than  mass production markets,  a transnational strategy appears to require the balancing of competing  and highly inconsistent  demands. Nevertheless,  recent  organizational,  logistical, and technological  innovations  have introduced   crucial flexibilities  in  production  and  distribution   functions that  facilitate the effective implementation of transnational—or “mass customization”—strategies. Organizationally,  the innovative global matrix structure   differs  from  traditional   architectures in that the control of a product  or service is the shared responsibility  of two managers,  one specializing in geographical regions (“localization” expert) and the other  in the  global production and  distribution  of the product or service (“economies of scale” expert). These managers work together to simultaneously handle localization and cost pressures.

Logistically, transnational firms handle cost pressures by designing its products  to use standardized components that  are  then  assembled  into  a basic machine  in a few large, strategically placed plants  (thus  meeting  the  “economies  of  scale”  requirement). The MNCs then deal with local pressures by sending the mass-produced product  to smaller finishing facilities for modification to regional demand and distribution  requirements. Technologically, the incorporation of information  technology and computer-aided design into mass production plants allow rapid  model  changeovers  (to meet  local demands) at low economies-of-scale costs. Industries that employ transnational strategies include pharmaceuticals, agricultural  equipment,  textiles and apparel, and automotive.

In general, business strategies that require consideration  of economies of scale—whether global or transnational—are more difficult to implement  than multidomestic  strategies  in terms  of need for coordination of information  and resources, integration  of functions and skills, and cultural controls.


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