6. Economies of scale
There are
three types of effects of size or quantity on efficiency (low
cost): economies of scale, scope and experience.
Economies
of scale are efficiencies due to ‘more of the same’: the quantity of
production per unit of time. There are
several forms of it. One is engineering economies, or ‘pots and pans
effect’, due to the fact that the content of a spherical container for
production (a reactor in oil and chemical industries, a building, a bulbous
vehicle), which determines production capacity, is proportional to the cube of
the radius of the sphere r (r3), while costs are a function of the
surface (material costs, weight and transport costs, loss of heat or cold by
radiation, ….), which is proportional to the square of the radius (r2).
As a result, the costs per unit production are proportional to the inverse of
the radius (1/r).
A second
economy of scale lies in specialization (as identified already by Adam Smith,
with his example of the pin factory): with a larger volume it pays to break
down a production process into steps of specialized activity (for labour or
machinery) that can be performed more efficiently than when they need to be
combined in one unit with more general capabilities. A qualification here is
that more integrated work can offer advantages of intrinsic motivation of
labour that can have a positive effect on efficiency, and programmable
machinery yields more flexibility.
A third
economy of scale lies in the efficient utilization of some capacity that is
available only in ‘chunks’: units of production with a minimum size. This can
be a machine or a worker. We find the latter, for example, in a shop where a
minimum of one attendant is needed during opening time, regardless of the
number and flow of customers. This is a threshold cost. As the volume of
production increases, the utilization of threshold capacity increases. At some
point additional capacity will be needed (or else customers will have to wait
too long to get service, and queues will lengthen), but then labour can be
employed part-time, only to cover peaks in demand. This economy of scale has
been the cause of a steady decline of the number of small shops. We find the
effect at any service point for customers (in retailing, recreation, health
care, municipal services, fire brigade, etc.)
Economy of scope
is efficiency due to the combination of different products using the
same resources. The classic example is that of an orchard in which trees must
be at sufficient distance for air and light, and space between them is utilized
for grazing cattle. Another classic example is the salesman of coal in winter
who sells ice-cream in summer. Another is the combination, in freighting, of
different products in one ride. Sometimes different products complement each
other technically, sometimes in combination they yield a portfolio of choice
for customers, and sometimes they pool and thereby spread risks. A
qualification here is that diversification into a variety of products may also
lead to a loss of efficiency due to a loss of focus on so-called core
competencies, diluting resources. An alternative is to reap the
advantages of scope in collaboration between different firms with different
focus.
Economy of experience
is efficiency due to an accumulation of production volume in time, creating
efficiency of learning by doing, in which expertise is honed, processes are streamlined
and redundant cost elements are eliminated. This yields what is called a learning
curve. A qualification here is that routinization in cumulative experience
may also yield lock-in, with blindness to new opportunities or needs and
an inability to change. For change one has to step onto the beginning of a new
learning curve, at a high level of initial cost.
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