Technical economies of scale result from efficiencies in the production process itself. Larger companies can take advantage of more efficient equipment. For example, data mining software allows the firm to target profitable market niches. Large shipping companies cut costs by using super-tankers. Finally, large companies achieve technical economies of scale because they learn by doing. Monopsony power is when a company buys so much of a product that it can reduce its per-unit costs.
For example, Wal-Mart can undercut smaller competitors by wielding its huge buying power. Managerial economies of scale occur when large firms can afford specialists. They more effectively manage particular areas of the company. For example, a seasoned sales executive has the skill and experience to take care of big orders. They demand a high salary, but they're worth it.
Financial economies of scale mean the company has cheaper access to capital. A larger company can get funded from the stock market with an initial public offering. Big firms have higher credit ratings and can offer lower interest rates on their bonds. Network economies of scale occur primarily in online businesses. It costs almost nothing to support each additional online customer with existing digital infrastructure.
So, any revenue from the new customer is all profit for the business. A company has external economies of scale if its size creates preferential treatment. That most often occurs with governments. For example, a state often reduces taxes to attract the companies that provide the most jobs. Big real estate developers convince cities to build roads to support their buildings, and this saves developers on those infrastructure costs.
Large companies can also take advantage of joint research with universities to reduce research expenses. Small companies don't have the leverage to benefit from external economies of scale, but they can band together.
Small companies can cluster similar businesses in a small area. That allows them to take advantage of geographic economies of scale. For example, artist lofts, galleries, and restaurants benefit by being together in a downtown art district. Organisation for Economic Co-operation and Development.
Accessed July 27, Harvard Business Review. FHS Economics. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. At one extreme, companies manufactured products close to their customers, tailoring regional operations at scattered plants to meet local needs. Other companies chose to centralize manufacturing, offering a selection of standard, lower priced products to all of the markets they served.
Yet given the current competition, which includes smaller, more focused companies as well as other multinationals, leading manufacturers must step beyond what has succeeded in the past.
As our work with Xerox Corporation, Digital Equipment Corporation, Coulter Electronics, and other companies indicates, moving toward global integration is a long, involved process that begins at the top, filters down through the organization, and includes innovations across all functions. Of course, there are no easy solutions to the need for change on such a large scale. All multinationals must grapple with their own unique problems; each must come up with its own innovations.
Still, while the focus varies from company to company, many manufacturers have tried similar approaches. Some have created international teams for different functions: international design teams or commodity management teams, for example. Others have emphasized doing a critical activity only once, such as designing a core product or entering a customer order. Regardless of the ways in which companies initiate change, one fact remains the same: multinationals must integrate their operations if they expect to compete in the volatile global arena.
They cannot go backward to complete centralization of manufacturing, or they will lose access to essential markets. Nor can they remain a disconnected system of geographically scattered operations. With a tightly coordinated network of plants in high-cost end markets and low-cost manufacturing centers, multinationals can achieve new economies of scale and cut costs by eliminating redundant processes.
But in becoming globally integrated, these same companies must balance the tension between a monolithic central authority and the need to integrate independent units. And they must focus specific changes in functions and at individual sites by articulating a vision shared by the entire organization. No multinational manufacturer can claim complete global integration, perfectly implemented, with no hitches or complaints, or provide an exact blueprint for others.
However, Xerox Corporation, with its complex web of international operations, embarked on a general strategy of global integration—and affirmed it publicly—at the right time. At the end of the s, Xerox was a typical multinational. The parent company, Xerox Corporation, designed and produced products in the United States for the U. Each Xerox company controlled its own suppliers, assembly plants, and distribution channels.
Plants in Mexico, the United States, Canada, Asia, Europe, and Brazil produced according to independently set schedules, based on forecasts from each individual operating company. The managers of these scattered plants gave little thought to how each one fit into the overall production plans of Xerox Corporation and rarely communicated with each other.
And since Xerox had a near monopoly on the worldwide copier market, no one, including top management at parent headquarters, felt pressured to do so.
Global integration was far from a well-defined strategy at the time, and managers did not pursue it with any urgency. But they accumulated information on the benefits of moving from a collection of independent regional units to a more integrated company. Then, as the s progressed, the competitive landscape started to shift. Xerox competitors such as Canon and Ricoh penetrated the U. More tellingly, in , Canon announced it was globalizing production of its copiers. Until that time, Canon had manufactured primarily in Japan and sold through a worldwide distribution network; it was, in effect, a typical centralized, export-oriented company.
But with new design and manufacturing facilities planned for the United States and Europe, Canon transformed itself into a decentralized multinational. As competitive pressures bore down, Xerox picked up its own pace, pursuing an explicit strategy of global integration.
During the critical period between and , Xerox made rapid innovations in many functions, which are highlighted in the time line that follows. The figures have also been adjusted to include Fuji Xerox, which is generally not consolidated for financial reporting purposes. This group of commodity managers identified and cultivated suppliers that could provide Xerox with high-quality, low-cost components on a worldwide basis.
For instance, Xerox now buys many of the lamps for its copiers from a single supplier with plants in Asia, Europe, and the United States. Senior managers recognized the power of such a program to improve communication of new management principles throughout its entire system of multinational operating companies and within the ranks of each company.
Functionally and geographically integrated teams took responsibility for introducing a new product in all major markets. Each product team managed the design, component sources, manufacturing, distribution, and follow-up customer service on a worldwide basis. One team designed a new product with universal power supplies and dual-language displays—for example, in both English and French—to eliminate the cost of reengineering for new markets at a later date.
In general, using integrated teams has cut as much as one year from the overall product development cycle and saved millions of dollars. This task force identified three levels of integration and used them as a basis for restructuring various operations at all facilities. Xerox plants were required to 1 adopt global standards for basic processes that apply to all operations for example, databases for managing materials ; 2 maintain common business processes but, where necessary, tailor them to local needs for example, just-in-time programs ; and 3 set site-specific processes for only those systems that must conform to local needs for example, government reporting requirements.
Information from this task force allowed top managers at Xerox to compare product cost and inventory data at different plants so they could balance production levels and improve utilization of excess inventory.
And when Xerox initiated a common just-in-time system, it also created a worldwide council that developed a set of metrics and goals for all plants to follow. They formed a multinational organization called Central Logistics and Asset Management CLAM and four multifunctional, product-focused teams to integrate the supply chain across geographic boundaries. The aim of CLAM is to base individual plant production levels on customer orders and to reduce excess inventory.
One team developed a new process that took more than a month out of the production forecasting cycle. The , manufactured in U. Before that time, Xerox had never introduced a major product in two distinct markets so quickly. In the past, the unique needs of the Japanese market, such as lighter weight paper, common use of blue pencils, and difficulties in copying kanji characters, meant separate product development programs for Western and Asian markets. That, in turn, meant products developed in this fashion required reengineering for other markets.
However, Xerox assembled a team of Japanese and American engineers to design the copier from concept to finished drawings. The design team also received feedback from customer groups in the United States, Europe, and Japan. A CLAM team and several operating groups created a Western Hemisphere distribution center for spare parts, consolidating safety stocks previously held independently for the U. Once again, such integration of operations saved Xerox several million dollars annually.
Xerox Corporation evolved its global-integration strategies over time and, to some extent, by trial and error. Realistically, changes at most multinationals do not happen neatly or in a fixed sequence. Similar small innovations may spark at the same time in several operating companies: automating certain parts of the manufacturing process, for example, or processing customer orders in a new way. While there is no fixed starting point for globally integrating an organization, managers, both at the top and in individual operations, should begin with focused projects that address specific problems.
It makes sense to focus first on a part of the organization where immediate and substantive improvement is possible. Xerox began its global-integration process in purchasing raw materials because management decided that was where it could make the most immediate and greatest gains. The following sections provide suggestions for integrating each function and, while not definitive, show the range of possibilities.
Product Development. Designing products once and only once for the global market benefits companies in a number of important ways. Such a design process can eliminate costly, after-the-fact redesigns every time a company wants to enter a new market with a particular product. For some suppliers, their client becomes so large it is just more efficient to open a factory in close proximity. Coca-Cola for example operates a similar function with its bottle manufacturers who operate in close proximity due to the sheer demand.
It, therefore, benefits the suppliers and the firm who both benefit from cheaper costs. As we can see from the graph below, the average cost to produce a unit decreases. However, when a business reaches a certain size, it can become less efficient — meaning the average cost to produce a unit increases.
For example, in extremely large and global businesses, there may be excessive amounts of bureaucracy. This can lead to less productive and inefficient workers. Workers may also become increasingly disengaged as management puts its efforts into other means, rather than managing the staff.
Some organizations become too big and lose sight of what is being spent. Layers and layers of organizational bureaucracy are put in place, making it inefficient for employees to do their job. At the same time, roles are split to benefit from the division of labor.
However, employees struggle to find the right person to contact out of the thousands of colleagues. This is where the Long-run average cost starts to increase again on the graph. Some of these advantages include:. The bigger a company becomes, the more customers it can serve — thereby allowing it to reduce costs per head. For example, companies with high fixed costs tend to benefit the most as these costs can be spread out per customer. Economies of scale reduce the unit price and by extension, produce greater profit margins.
As a firm gets bigger, it starts to sell to more customers. When combining lower costs and higher customer volumes — higher profits result. As a company grows larger, its presence in the market also increases. Customers start to become aware of its brand and develop trust in it — which allows the firm to establish its position in the market.
It may also be afforded lower interest rates as well as greater availability of credit. As a business grows and increases its presence in the market, it hires more workers and becomes a more integral part of the economy. In turn, it is able to use this fact to lobby the government for regulatory change.
For instance, it might be to leave the country because the regulatory costs are too high. As the firm is able to reduce its average cost per unit — it can feed into lower prices for the consumer. Whilst some companies will take all the profits from increased efficiency — firms in a competitive market will pass on some of the cost savings to the customer.
As a company grows larger, it often seeks to grow further. Now the best way of doing that is by extending its existing offering and attracting new customers — which leads to greater consumer choice.
In a competitive market, economies of scale can lead to growing wages as firms have lower costs. This is why big firms are able to afford higher salaries than local competitors. As the firm grows, production starts to become more efficient.
In turn, they are able to offer higher wages than competitors to attract the top talent. There are several disadvantages that can occur due to economies of scale. These can present several disadvantages such as:. When a firm grows, it sets up numerous departments for specific tasks. Now that may benefit the firm through the division of labour , but it makes communicating between teams difficult.
For instance, who do you speak to if you have a problem with X. Often in such big companies, you are passed on and on and on again — taking, what should be an easy issue to resolve, significantly longer.
As the firm grows, management may go from having one or two delegates, to having 10 or 15 people working under them. It is far easier to monitor and assist a smaller team rather than keeping tabs on a large workforce. In small companies, there may be a nice community feel whereby everyone knows each other and are all friendly.
They are something small and insignificant in this large company — which can contribute to poor employee engagement and performance. When there are thousands of employees in one firm — it is very easy for two or more people to end up doing the same tasks. This is particularly prevalent when considering poor communication as a factor. On occasion, this has led to boycotts. Yet a small local store doing the same may not face such criticisms. Quite simply, bigger stores are held to a higher standard.
Economies of scale occur when a firm grows in size. An example of such are purchasing economies of scale. The firm benefits from being able to make bulk purchases at a lower price, thereby benefiting from lower costs. Economies of scale are caused by firms growing to a size by which they are able to benefit from a number of efficiencies.
External economies are slightly different from internal in the fact that the occur outside, independently of the firm, but within the industry. So for example, the local council may build a new railway line. The local businesses may benefit from cheaper transport, and potentially a greater influx of new customers. There are both Internal and External economies of scale.
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