scale-of-operations

Factors influencing the scale of business operations

• The scale of operations refers to the size and extent of a business’s activities, including:

  • how much it produces

  • how widely it sells

  • how many resources it uses

• Businesses do not all grow to the same size, as a range of internal and external factors influence how large they become

Internal and external factors affecting the scale of operations

Size of the market

• If the business operates in a large or fast-growing market, it may have more opportunities to grow

• In contrast, niche or local markets may limit how large a firm can become

  • Bigger markets = more potential customers

  • Smaller markets = fewer opportunities to expand

Capital available

• A firm with access to large amounts of capital, such as retained profit, loans or share capital, is more likely to expand

  • More capital = more investment in equipment, staff or premises

  • Limited finance = restricted growth

Number and scale of competitors

• A highly competitive market may force firms to grow quickly to survive

• Too many rivals may prevent growth if it is hard to gain market share

  • Fewer competitors = easier to dominate the market

  • Too many competitors = harder to grow profitably

Scope for economies of scale

• Businesses that can reduce their average costs as they grow may be more motivated to expand

  • This is common in manufacturing or transport industries

  • Businesses in services may have fewer cost-saving benefits from growing larger

Objectives of business owners

• Some owners prefer to keep their businesses small for easier control, better work-life balance or to maintain quality

• Some owners prioritise independence or lifestyle

• Others want rapid growth, high profits or global expansion

Economies of scale

• As a firm grows, it is able to increase its scale of output, generating efficiencies that lower its average costs of production

  • These efficiencies are called economies of scale

Internal economies of scale

• Internal economies of scale occur as a result of the growth in the scale of production within the firm

Types of internal economies of scale

Financial

• Large firms often receive lower interest rates on loans than smaller firms, as they are perceived as less risky

Managerial

• It occurs when large firms can employ specialist managers who are more efficient at certain tasks

• Managers in small firms often have to fulfil multiple roles and are less specialised

Marketing

•  Large firms spread the cost of advertising over a large number of sales

• They can also reuse marketing materials in different geographic regions

Purchasing

• This occurs when large firms buy raw materials in greater volumes and receive a bulk purchase discount

Technical

• Occur as a firm is able to use its machinery at a higher level of capacity due to the increased output, thereby spreading the cost of the machinery over more units

External economies of scale

• External economies of scale occur when there is an increase in the size of the industry in which the firm operates

Sources of external economies of scale

Diseconomies of scale

• Diseconomies of scale occur when a business grows too large, causing its average costs per unit to increase as output rises

  • Diseconomies of scale highlight that it is possible for a business to become so large that it becomes less and less efficient

• A business experiencing diseconomies of scale may reconsider its organisational structure to improve communication and coordination problems

  • Many very large businesses often break themselves up into autonomous smaller units, which can communicate more effectively

The causes of diseconomies of scale

Poor communication

• As a business increases in size, more managers and employees join the business

• Communication becomes slower and mistakes may be made, leading to worsening efficiency

Weak coordination

• Time-consuming decision-making may make it harder to coordinate workers and physical resources

• The chain of command is likely to lengthen, limiting interaction with employees

Lack of commitment from employees

• As the business grows, workers may feel less valued as their interaction with management is limited

• Workers may become demotivated, leading to a fall in output

Unit costs and economies and diseconomies of scale

• Economies of scale help large firms lower their costs of production beyond what small firms are able to achieve

• They are the reason that firms generate increasing returns to scale in the long run

The long-run average cost curve

• With relatively low levels of output, average costs are high

• As output increases, the business begins to benefit from economies of scale, which lower the average cost per unit

• At some level of output, the business will not be able to reduce costs any further; this point is called productive efficiency

• Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale