Economies and Diseconomies
of Scale
IB Unit 1.7 - GROWTH
Learning Objectives
By the end of this lesson, students should
be able to:
•Evaluate PESTLE influences on a
company’s objectives/strategies
•Understand the six different economies of
scale businesses can benefit from
•Demonstrate knowledge of the six different
economies of scale
•Understand how a business can also suffer
from diseconomies of scale
Evaluating the impact on a firm’s
objectives and strategy of a change
in any of the PESTLE factors
• Once a PESTLE is carried out, the next
step is to work out how much these
external factors will impact on the firm and
therefore should they alter their objectives
and strategies to help better deal with
these impacts.
• Lets look at the online retail market…
Evaluating the impact on a firm’s
objectives and strategy of a change
in any of the PESTLE factors
•
•
•
•
•
STEEPLE on Music Industry
2008
Economic – Sales of Compact Discs had fallen with
a US recession forecast. Fierce competition from the
market leader in legal downloads – Apple iTunes
Social – The increasing confidence of consumers to
order and pay for songs over the Internet
Legal – In order to build a library of songs, Amazon
forms a strategic alliance with Warner Brothers to
facilitate sales
Technological – Increased use of broadband and
the increasing threat of rival, free, peer-to-peer sites
such as Limewire
Political – Perceived weak Government action in
prosecuting ‘music pirates’
Evaluation of Changing objectives
as a result of STEEPLE analysis
• Amazon’s decision, given the difficult trading
conditions since January 2008, would appear
to have been successful. A number of
electronic retailers in the US and UK have
since gone into administration and sales of
legally downloaded songs has increased
• Only drawback is they may have cannibalised
their own market, with customers only buying
individual tracks rather than whole albums.
Unit 1.7SL – Growth & Evolution
• “Be not afraid of going slowly; be afraid
only of standing still”
• There are two methods of business growth and
these are known as organic growth and
external growth. Organic growth occurs when
a business grows internally, using its own
resources to increase the scale of its operations
and sales revenue. Internal growth is typically
financed through profits of the business.
How Businesses Grow….
The Growth of Firms
• Firms grow in three main ways:
1)Merging with other firms (External Growth)
- A merger takes place when two or more
firms agree to join together to become one
larger firm. E.g.:
The Growth of Firms
• Firms grow in three main ways:
2)Taking over another firm (External
Growth). – A takeover occurs when one firm
buys control of another. This is achieved by
buying enough shares in the firm to be able to
outvote other shareholders. E.g.:
The Growth of Firms
• Firms grow in three
main ways:
3)By Internal
Expansion – This is
when the business
grows by increasing its
production, perhaps by
building a new plant or
new shops by
ploughing profits back
in to the firm. E.g.:
Why is Bigger better?!?!
• Definition – As the business grows, the
firm’s unit costs decrease
• As businesses increase their capacity of
production they can benefit in so many
ways from ECONOMIES OF SCALE
• E.g:
Sainsbury’s Distribution Centre
7kms of conveyor belts
750,000 square feet (247 tennis courts)
2 million cases a week
300 employees
What benefits might a firm
achieve through operating on
this scale?
PURCHASING Economies of Scale
1 Mars Bar = 50 cents
Box of 50 Mars Bars = $10
Therefore 1 Mars Bar now = $10/50 = 20 cents
Therefore supermarkets such as Carrefour
have the capacity to buy thousands of
Mars bars, charge 40p per Mars bar
cheaper than a newsagents and still make
a healthy profit because the cost per unit
is lower for Carrefour than it is for a smaller
shops
PURCHASING Economies of Scale
1 Cow = $2
1 McDonalds Cheeseburger = 69 cents
Therefore McDonalds would make a loss
if they only made 1 cheeseburger a day
1 Cow = $2
10 McDonalds Cheeseburger = $6.99
Therefore because McDonalds
have the capacity to produce and
sell more cheeseburgers, they can
buy cows in bulk and charge
such a low price for their
cheeseburgers and still make a
healthy profit.
FINANCIAL Economies of Scale
Because Liverpool FC are such a large institution, the Royal Bank of
Scotland was more willing to lend huge amounts of money to the club at very
low interest rates to attract such a large customer.
So it is easier for large firms to raise capital, and larger
firms benefit from lower interest rates
MARKETING Economies of Scale
Coca-Cola
advertises globally
which is very
expensive but
compared to the
total amount of
products they sell,
the cost is spread
and this results in a
low unit cost for
Coca-Cola
RISK-BEARING Economies of
Scale
Firms such as Coca-Cola & Mars are so large they sell a huge range
of products so they do not just rely on one product to be successful. If
one product fails they have many other products to keep the company
successful and profitable
MANAGERIAL Economies of Scale
Firms such as Carrefour are large enough to afford to employ
specialist managers who improve the efficiency of the firm. Whereas
small firms like B&M can’t afford specialists like this
TECHNICAL Economies of Scale
Firms such as Tesco are large
enough to afford to save on
costs by using better methods
and equipment such as selfserving machines saving
money in the long-run on
labour costs
1.7 Growth Lesson 2 Learning
Objectives
• Define the various methods of organic and
external growth (ALL)
• Analyse the most suitable methods of
growth for businesses in a given scenario
(MOST)
• Analyse how effective a businesses
growth strategies are in a given scenario
(MOST)
Types of Growth Integration
• The diagram
shows different
ways in which
Virgin Wines
may grow:
Backwards Vertical Integration
Vineyard Farmer
Horizontal Integration
Diversification
Virgin
Start a
Champagne
Purchases a
Wines
Business
Fruit
Drinks Business
Forwards Vertical
Integration
Open a Virgin Wines
Shop
Growth Methods in More detail..
Organic Growth
• See worksheet
External Growth
• See Worksheet
External economies of scale
This is usually associated with an industry of large
businesses who are located near each other
• Technological progress: which increases the
productivity of trading within an industry.
• Improved transportation and communication
networks: Help to ensure deliveries and staff arrive on
time.
• Better trained labour: Provides businesses with a
suitable pool of educated labour reducing recruitment
costs without compromising productivity.
• Regional specialisation: an area may have a specific
high regard for producing a specialised product, this will
mean there will be specialist labour in the area as well as
the firm being able to charge a premium price.
Diseconomies of Scale
• Average costs do not always fall as the
scale of production is increased. If they
rise, a firm is said to experience
diseconomies of scale. These usually
occur because the firm becomes too big to
be managed efficiently. E.g….
Virgin’s Diseconomies of Scale
Virgin’s Diseconomies of Scale
• The retailing arm of Sir Richard Branson's
Virgin empire has recorded a £44m loss in
its most recent financial statement
AOL/Time Warner
INTERNAL DISECONOMIES OF SCALES
• Businesses can actually become too large. There
comes a point where economies of scale can no
longer become exploited. Diseconomies of scale
are the result of higher unit costs.
– Managerial problems, managers may have
lack of control and experience the need for a
longer amount of time to communicate with
extra staff.
– Poorer working relationships - workers feeling
alienated and out of touch and therefore demotivated.
– Staff may do boring tasks and be a scope for
slack amongst the workforce
EXTERNAL DISECONOMIES OF SCALE
• This refers to an increase in the average
cost of production as a firm grows which
are out of its control.
– Too many businesses wanted to locate in a
certain area leads to an increase in the rent
they have to pay
– Traffic congestion may lead to deliveries being
delayed
– Labour supply, workers may have a choice
where to work so a business may have to offer
a higher wage.
Sony Ericsson A)
Sony Ericsson B)
Disney/Pixar A)
Disney/Pixar B)
Disney/Pixar C)
ECONOMIES OF SCALE
• The scale of the McDonalds Olympic operation is
quite impressive:
- 470 staff
- Expected sales: 1.75 meals (compared with
current monthly sales of around 72 million meals
per month).At the Beijing Olympics in 2008,
McDonalds sold 1.25 million meals
- Seating capacity of the flagship outlet (3,000
square metres in size) is 1,500 customers (ten
times the size of an average McDonalds outlet in
the UK
- During the Games, the outlet will be the busiest
in the world for the brand (currently Pushkin
Square outlet in Moscow)
Key term definitions
3. Internal economies of scale – the cost
benefits that an individual firm enjoys
when it expands.
4. External economies of scale the cost
benefits that all firms enjoy when the
industry expands.