What is Meant by Economies of Scale Essay

Read the article from the BBC News website about supermarkets in the UK. With reference to supermarkets, explain what is meant by economies of scale.

Economies of scale can be defined a cost advantage that a company enjoys after increasing its level of output. In most cases for a firm to achieve this it has to reduce lower its costs. This is done by spreading it (cost) over a large number of goods. From the BBC news website supermarkets in the UK have been forming mergers to enjoy economies of scale (Simpson, 2018). They have been partnering with big multinational companies to cut on costs completely. 

Cost is subdivided into viable and fixed. A fixed cost is one that must be met despite the amount a firm produces, it is a mandatory charge. On the other hand the variable cost fluctuates as it depends on a couple of factors, such as quantity of output. When it comes to economies of scale size of supermarket is of essence. The larger the entity is the more the cost savings will be. The competitive advantage that supermarkets have over the small retail entities is an attribute of economies of scale. Big stores have a low per-unit cost.

Economies of scale are an essential concept for any business regardless of the industry.  Most people find it hard to understand why some commodities are cheap in supermarkets but slightly expensive in small shops. The reason behind this is that due to the large size of a supermarket it is able to spread the cost of production over many products.

Types of economies of scale

Economies of scale are divided into two, namely: internal and external. He internal economies are within the firm hence can be controlled by management. Larger companies such as supermarkets are able to achieve internal economies of scale by increasing their stock and lowering their costs. This is attainable because the entity buys resources in bulk, have access to sufficient capital and special technology unlike small shops.

External economies deal with external factors affecting the industry such as the government, geographic location among others (Segal, 2019). External economies of scale are achieved because factors are affecting the whole industry. There is no one firm that can control these costs alone. These economies occur when there are subsidies, a highly skilled labor pool, tax reduction or anything cutting down on costs for many organizations in a certain industry.

Sources of Economies of Scale

Specialization of labor and capital – Through specializationtime is savedand wastage reduced because individuals are assigned a task that they can handle perfectly.

Lower shipping costs – When the transportation cost is low a company is able to offer its products at a lower price.

Mass production techniques – The benefit of this is that it saves on time and labor required.

Ability to raise finance more cheaply – Because of the asset a company has it becomes easy for banks to lend out money.

Administrative and marketing economies – average cost is lower when the management structure and marketing strategies are improved.

More efficient supply chain and distribution network – when the supply chain is efficient it means that a company is serving a big market, hence high sales.

Discounts for bulk purchasing – Large entities are granted a significantly enormous discount because they buy their requirements in bulk. This discount enables them to lower average costs.

Advantages of economies of scale

Lower Costs per Unit

The chief advantage of economies of scale is reduction in cost per unit sold. Supermarkets benefit from this and it helps them to always be on top of small entities competitors

Greater Market Potential

Economies of scale frequently correspond to a company’s efforts to ramp up consumer demand. This can occur because of lower prices or aggressive marketing. Nevertheless, when demand is increased, sales follow suit.

Cheap and Easy Loans

A large supermarket can easily access a crediting facility at cheap rates. The reason behind this is the reputation such a firm has in the market because of its fixed assets. It is likely for financial institutions and banks to grant advance loans to these enterprises at a considerably low rate of interest.

Problems of economies of scale

A company becomes less flexible and takes a lot of time in decision making process (Segal, 2019). Take for instance a big supermarket that has several branches all over, if it is planning on rebranding all branch managers must be consulted. Obviously this will consume quite a lot of time.

Also because of the large size miscommunication is likely to occur, particularly if the entity becomes global. The reason behind this is that it is hard to pass a message effectively to every staff member when an organization is large. Moreover acquiring new firms might cause a clash of organizational culture, and this might slow progress if cultural diversity is not managed.

Sales Pressure

To attain economies of scale in the long run, the sales output usually have to increase in kind. Some firms take the risk of purchasing resale goods in vastness hoping that sales volume will increase. Management is forced to hire more staff and invest heavily in marketing efforts to create a greater business. This continuous pressure puts company leaders at a hot spot.

Diseconomies

It is possible for a company to become too large as it chases economies of scale; such is referred to as diseconomy of scale.

As a company continues to expand, requires more layers of management to keep track of operations. More management implies that delegation of more work is necessary. Communication between the different levels of management might be an issue.  It could be possible for specialized workers to be disenchanted and alienated from their job.

References

Segal, T., (2019). External Economies of Scale. [Online] (updated 18 Apr 2019) Available at:< https://www.investopedia.com/terms/e/externaleconomiesofscale.asp> [Accessed 11 Nov 2019]

Simpson, E., 2018. Asda Saunbury’s merger talks ‘sign of changing retail world.’ [Online] (updated 28 Apr 2018) Available at:<https://www.bbc.co.uk/news/business-43936542> [Accessed 11 Nov 2019]

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