Factors Influencing the Scale of a Business
Scale of operations refers to the size of a business’s operations, such as the amount it produces, the number of employees it has, the size of its premises or the markets it serves.
A business may operate on a small, medium or large scale.
Market Demand
→ High demand → business may increase production capacity → larger scale of operations.
→ Limited demand → expanding production may leave resources underused → business may remain small.
Example: A business selling a popular product may expand production to meet rising demand.
Availability of Finance
→ More finance available → greater ability to invest in machinery, premises, technology and employees → larger scale.
→ Limited finance → expansion may be difficult.
Owner’s Objectives
Not every business wants to become large.
→ Some owners want rapid growth and higher profits.
→ Others may prefer a small business with greater personal control and lower risk.
Nature of the Business
Some industries naturally operate on a large scale.
→ Car manufacturing → large factories and expensive machinery
→ Airlines → large investment in aircraft and infrastructure
Other businesses can operate effectively on a smaller scale.
→ Hairdressers
→ Small restaurants
→ Specialist consultants
Technology
→ Automation and advanced machinery → higher production capacity → may encourage large-scale operations.
Technology can also allow small businesses to operate efficiently without employing large numbers of workers.
Availability of Labour
→ Large supply of suitable workers → easier to expand.
→ Shortage of skilled workers → may limit expansion.
Government Policies
→ Grants and subsidies → reduce cost of expansion → encourage growth.
→ Taxes and regulations → may increase costs → discourage expansion.
Competition
→ Strong competition → business may need to expand to reduce costs and remain competitive.
→ A small business may instead focus on a specialist market or niche.
Access to Raw Materials and Suppliers
→ Reliable supply of materials → easier to increase production.
→ Limited or unreliable supplies → may restrict the scale of operations.
International Markets
→ Access to international markets → larger potential customer base → greater opportunity for expansion.
Economies of Scale
Economies of scale occur when the average cost per unit falls as the scale of production increases.
Formula:
Average cost (unit cost) = Total cost ÷ Output
Internal Economies of Scale
Internal economies of scale are cost advantages that arise from the growth of the individual business.
Purchasing Economies
A large business can buy raw materials in large quantities.
→ Large orders → greater bargaining power → bulk discounts → lower cost per unit → lower unit costs.
Example: A large supermarket chain may negotiate lower prices from suppliers because it buys huge quantities.
Technical Economies
Large businesses can afford expensive machinery and technology.
→ Investment in advanced machinery → higher productivity → more output → lower average cost.
Example: A large car manufacturer can use automated production lines that would be too expensive for a small producer.
Managerial Economies
Large businesses can employ specialist managers.
→ Specialist managers → greater expertise → more efficient decision-making → lower costs.
Example: A large business may employ separate specialists in finance, marketing, HR and operations.
Financial Economies
Large businesses may find it easier to obtain finance and may receive loans at lower interest rates.
→ Larger/reputable business → lower perceived risk → easier access to finance → potentially lower borrowing costs.
Marketing Economies
The cost of advertising can be spread over a larger output.
→ Large advertising campaign → high fixed marketing cost → many units sold → lower advertising cost per unit.
Example: A national advertising campaign may be expensive, but the cost per product sold can be relatively low for a large business.
Risk-Bearing Economies
Large businesses may be able to spread risks across different products and markets.
→ Different products/markets → lower dependence on one source of revenue → greater ability to absorb losses in one area.
Example: A multinational business operating in several countries may be less affected by weak demand in one country.
External Economies of Scale
External economies of scale are cost advantages that arise because the industry or area in which the business operates grows, rather than because of the growth of the individual business.
Skilled Labour
→ Industry grows → more workers trained in relevant skills → larger pool of skilled labour → easier and potentially cheaper recruitment.
Specialist Suppliers
→ Industry grows → specialist suppliers establish themselves nearby → greater supplier competition and availability → lower input costs.
Improved Infrastructure
→ Industry expands in an area → government improves roads, ports, electricity or communication systems → lower operating and transport costs for businesses.
Industry Knowledge and Technology
→ Industry becomes concentrated in an area → businesses share knowledge and benefit from specialist services → improved productivity and potentially lower costs.
Example:
→ A technology cluster develops → universities train skilled workers → specialist suppliers develop → businesses gain easier access to skills and services.
Diseconomies of Scale
Diseconomies of scale occur when the average cost per unit rises as the business becomes larger.
Growth does not always make a business more efficient.
Internal Diseconomies of Scale
These arise from problems within the individual business as it becomes too large.
Communication Problems
→ Larger business → more employees and management levels → messages take longer to pass through the organisation → misunderstandings and delays → higher costs.
Management Problems
→ Business becomes very large → managers find it difficult to monitor operations → weaker control → inefficiency → higher costs.
Coordination Problems
→ More departments and locations → greater difficulty coordinating activities → duplication and delays → increased costs.
Employee Motivation Problems
→ Very large organisation → employees may feel less connected to management → lower motivation → lower productivity → higher unit costs.
Bureaucracy
→ Larger organisation → more rules and procedures → slower decision-making → increased administrative costs.
External Diseconomies of Scale
External diseconomies occur when the growth of an industry or concentration of businesses creates higher costs for businesses in that area.
Examples include:
→ Traffic congestion → longer delivery times and higher transport costs
→ Higher demand for land → higher rents
→ Increased competition for workers → higher wages
→ Pressure on local infrastructure → delays and higher operating costs
→ Shortages of raw materials → higher input prices
Example:
→ Many businesses locate in the same industrial area → demand for skilled workers increases → wages rise → production costs increase.
Economies, Diseconomies and Unit Costs
The relationship can be summarised as:
→ Increasing scale + economies of scale → falling average/unit cost
→ Increasing scale + constant returns to scale → broadly unchanged average/unit cost
→ Increasing scale + diseconomies of scale → rising average/unit cost
The key reason is that economies of scale allow a business to spread costs or operate more efficiently, while diseconomies create inefficiencies as the business becomes excessively large.
Overall Cost Relationship
→ Business expands → output increases → economies of scale → unit cost falls
But eventually:
→ Business becomes very large → communication/coordination/management problems → diseconomies of scale → unit cost rises
This is why a business needs to consider whether further expansion will reduce or increase its unit costs, rather than assuming that becoming larger will always be beneficial.