Productive Efficiency
Content
• Economies of scale:
– Internal economies
– External economies
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Diseconomies of scale
Capacity utilisation
Capital vs labour intensity
Research and development
Critical Path Analysis
Economies of Scale
• These occur when mass producing a good results
in lower average cost.
• Average costs fall per unit – Average costs per unit
= total costs / quantity produced
• Economies of scale occur within an firm (internal) or
within an industry (external).
Internal and External Economies
• Internal Economies of Scale
As a business grows in scale, its costs will fall due to
internal economies of scale. An ability to produce units
of output more cheaply.
• External Economies of Scale
Are those shared by a number of businesses in the
same industry in a particular area.
Types of internal economy
of scale
Example
Production / Technical
Economies
•Larger firms can use computers / technology to replace workers on a
production line
•Mass production lowers cost per unit
•Large scale producers can employ techniques that are unable to be
used by a small scale producer.
•Able to transport bulk materials.
Purchasing / Marketing
Economies
• Advertising costs can be spread across products
•Large businesses can employ specialist staff
• Bulk buying – if you buy more unit cost falls
Financial Economies
•Larger firms have better lending terms and lower rates of interest
•Easier for large firms to raise capital.
•Risk is spread over more products.
• Greater potential finance from retained profits.
• Administration costs can be divided amongst more products
Managerial Economies
• More specialised management can be employed, this increases the
efficiency of the business decreasing the costs
Risk-bearing Economies
• large firms are more likely to take risks with new products as they
have more products to spread the risk over
External Economies of Scale
• These are advantages gained for the whole
industry, not just for individual businesses.
Examples of External Economies
• As businesses grow within an area, specialist skills
begin to develop.
• Skilled labour in the area – local colleges may begin
to run specialist courses.
• Being close to other similar businesses who can
work together with each other.
• Having specialist supplies and support services
nearby.
Diseconomies of Scale
• Occur when firms become too large or inefficient
• Average costs per unit start to rise
Diseconomies of Scale
Types of diseconomy of
scale
Example
Communication
•When firms grow there can be problems with communication
•As the number of people in the firm increases it is hard to get the
messages to the right people at the right time
•In larger businesses it is often difficult for all staff to know what is
happening
Coordination and control
problems
•As a business grows control of activities gets harder
•As the firm gets bigger and new parts of the business are set up it is
increasingly likely people will be working in different ways and this
leads to problems with monitoring
Motivation
•As businesses grow it is harder to make everyone feel as though they
belong
•Less contact between senior managers and employees so employees
can feel less involved
•Smaller businesses often have a better team environment which is
lost when they grow
Capacity Utilisation
• This looks at the amount a firm is producing
compared with how much it could be producing
given existing resources
• To increase capacity utilisation can increase
production levels
• Need to ensure there is demand for the excess
production
Capacity utilisation
• If produce more need to increase demand by:
– Increased promotion
– Altering elements of the marketing mix to increase
demand
– Producing products for other firms (sub contracting)
Rationalisation
• Where firms are producing under capacity however
don’t foresee an increase in demand they will
reduce production to cut costs
Capital Vs labour intensity
• Capital intensive businesses are where there is a
high level of capital equipment compared to labour
input in the production process
• Labour intensive businesses are where there is a
high level of labour input compared to capital
equipment in the production process
Research and Development
• All activities that look at identifying new products /
services and new ways of producing
• Need to be able to turn the ideas into products that
can be sold
• Innovation – where new ideas are turned into
products
Research and Development - Aims
• To develop new products which have USPs allowing
for product differentiation
• Increasing the quality of products to increase
customer satisfaction
• To develop more effective ways of producing to
decrease costs per unit
• These can all increase the profitability of the
business
Research and development process
• The research and development process:
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Idea generation
Screening of ideas
Development of ideas
Prototype and testing
Launch
How to protect innovations
• If a business is successful with innovation needs to
protect them from competition
• A patent gives the holder sole use of a process /
sole manufacture of a product for the next 20 years
• Copyright protects the work of artists / writers and
musicians
Research and development and the PLC
• Research and development happens before the
introduction phase of the product life cycle
• Research and development is very expensive so
can often cause cash flow problems prior to the
launch of products
• After launching a product businesses need to do
more research and development to modify the
product or bring out a new product to increase
demand and profit
Research and Development
• If research and development is good then it
considers design issues
• In addition it needs to look at :
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Customer needs
Use of product / service
Competitors products
Ease of manufacture
Costs / quality / profit targets
Research and Development and Risk
• All research and development contains an element
of risk
• Therefore businesses need to ensure that research
and development minimizes risk to get required
results
• Cant guarantee the success of innovations however
firms can try and encourage and support research
and development
Why use CPA?
Critical Path Analysis is a planning and
management tool with the following advantages:
• Allows a business to plan ahead- efficiency
• Is time related giving an accurate plan
• Enables resources to be planned ahead
• Allows for good management
• Helps with cash flow management
• Reduces waste
Critical Path Analysis
• May be used as part of the decision making process to allow a
business to plan and monitor operations
• Time related – identifies the maximum time for an operation to be
completed
• Identify potential problems in implementing operation
• Identifies where and when resources (including human ones) are
needed
Critical Path Analysis
• Advantages
– Maximise efficiency in the
use of time
– Improve efficiency and
generate cost saving in the
use of resources
– Beneficial to monitoring
cash flow
• Disadvantages
– Usefulness may be limited
in complex and large scale
operations
– Necessity of having clear
and reliable information
– Skilled management and
team philosophy is
essential
CPA – the Process
• Identify and prioritise the activities and how long each task will
take to do
• Identify which activities MUST be done before others
• EST – identify earliest start time
• LFT – identify latest finish time
• Identify the FLOAT – tasks which can be completed outside
the critical path
• Identify the critical path – points connecting ESTs and LFTs
(where these are the same)
Critical Path Analysis
Node numbers showing order of
activities in the left hand semi-circle
of each node.
1
A
3
The Critical Path
2
Earliest Start Time (EST)
5
5
B
5
Arrows
indicate the
order of the
tasks, the
letter above
shows the
order, the
time period
below the
arrow
Latest Finish Time (LFT)
Nodes: Show the start and finish of a task
Summary
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Economies of scale are were costs per unit decrease as a firm grows in size
Internal economies are specific to one firm as it grows in size e.g. technical,
purchasing, marketing
External economies involve a number of firms
Diseconomies of scale occur when the firm experiences a rise in unit costs as the
firm grows e.g. communication
Capacity utilisation measures how much of the production capacity is used by the
organisation
Capital intensity is where production is most reliant on capital
Labour intensity is where production is most reliant on labour
Research and development is where businesses come up with new ideas for
products and processes
Critical Path Analysis is a planning and management tool