Economies of Scale: Internal and External Factors
External Economies of Scale
External economies of scale are efficiencies that a business achieves due to the expansion of external factors.
- Consumers: In a shopping mall, people enter various stores, so the small businesses in the mall will benefit.
- Employees: If a specific geographic area has a concentration of a certain industry, a business working in that area can benefit from the workers (low recruiting/training costs).
Internal Diseconomies of Scale
Internal diseconomies of scale are inefficiencies a business creates itself.
- Technical: Airplane too big for an airport.
- Managerial: Overly specified workers that can only work in one area.
- Financial: Businesses with a large amount of excess production can make poor investments.
- Marketing: If a business promises a deal to customers and does not honor it, they may face legal problems.
- Purchasing: Large businesses that buy too much stock can lose money if it becomes unfashionable or spoiled.
- Risk-bearing: If a company buys another one from a different area and cannot manage it correctly, they may have to resell it.
External Diseconomies of Scale
Employees: If an area becomes concentrated in a certain job, there will be few skilled workers, and it would be expensive to attract or retain them.
Advantages of Big Businesses
- Survival: Fewer chances of failing and being taken over by competitors.
- Economies of scale.
- Higher status.
- Market leader status: Leaders can shape market habits, gaining a competitive advantage.
- Increased market share: They can control marketing.
Advantages of Small Businesses
- Greater focus: Focus where they want, in places with greater profitability, in specific markets.
- Greater cachet: Greater sense of exclusiveness, so they can charge more for their output, leading to higher profit margins.
- Greater motivation: More prestige can motivate managers and employees.
- Competitive advantage: Giving a more personalized service and being more flexible.
- Less competition: Focusing on a niche provides limited competition.
Internal Growth
Internal growth is slow and steady. Businesses do not take many risks. It expands by selling more products or by increasing its product range. It is usually self-financed.
External Growth
External growth involves quick and riskier methods. It expands by entering into an arrangement with another business. It usually needs financing.
Mergers and Acquisitions
Two businesses integrate by joining into a bigger business or by an acquisition.
Horizontal Integration
Businesses in the same line and chain of production. For example, when Disney bought Pixar.
Backward Vertical Integration
A business integrates with another at an earlier stage in the chain of production to protect its supply chain. For example, when Starbucks buys a coffee manufacturer.
Forward Vertical Integration
A business integrates with another at a later stage in the chain of production to ensure a secure outlet.
Conglomeration (Diversification)
Two businesses in unrelated lines integrate.
Joint Ventures
Two businesses combine resources for a specific goal over a finite period. They do not lose their legal existence or identity. It is like a partnership.
Strategic Alliances
Businesses collaborate for a specific goal. No new business is created; there is no new legal entity. Businesses remain independent. Weaknesses: More businesses mean more challenging coordination and agreements.
Franchises
A franchisor (business) sells the right to offer their concept and sell their products. It has to be consistent and identical to the business concept.
Responsibilities of the Franchisor
- The stock.
- Global advertising and promotion.
- Legal and financial help.
- Staff training.