Productive Efficiency

Content

• Economies of scale:– Internal economies– External economies

• Diseconomies of scale• Capacity utilisation• Capital vs labour intensity • Research and development• Critical Path Analysis

Economies of Scale

• These occur when mass producing a good results in lower average cost.

• Average costs fall per unit – Average costs per unit = total costs / quantity produced

• Economies of scale occur within an firm (internal) or within an industry (external).

Internal and External Economies

• Internal Economies of ScaleAs a business grows in scale, its costs will fall due to internal economies of scale. An ability to produce units of output more cheaply.

• External Economies of ScaleAre those shared by a number of businesses in the same industry in a particular area.

Types of internal economy of scale

Example

Production / Technical Economies

•Larger firms can use computers / technology to replace workers on a production line •Mass production lowers cost per unit •Large scale producers can employ techniques that are unable to be used by a small scale producer.•Able to transport bulk materials.

Purchasing / Marketing Economies

• Advertising costs can be spread across products•Large businesses can employ specialist staff • Bulk buying – if you buy more unit cost falls

Financial Economies •Larger firms have better lending terms and lower rates of interest •Easier for large firms to raise capital.•Risk is spread over more products.• Greater potential finance from retained profits.• Administration costs can be divided amongst more products

Managerial Economies • More specialised management can be employed, this increases the efficiency of the business decreasing the costs

Risk-bearing Economies • large firms are more likely to take risks with new products as they have more products to spread the risk over

External Economies of Scale

• These are advantages gained for the whole industry, not just for individual businesses.

Examples of External Economies

• As businesses grow within an area, specialist skills begin to develop.

• Skilled labour in the area – local colleges may begin to run specialist courses.

• Being close to other similar businesses who can work together with each other.

• Having specialist supplies and support services nearby.

Diseconomies of Scale

• Occur when firms become too large or inefficient• Average costs per unit start to rise

Types of diseconomy of scale

Example

Communication •When firms grow there can be problems with communication•As the number of people in the firm increases it is hard to get the messages to the right people at the right time•In larger businesses it is often difficult for all staff to know what is happening

Coordination and control problems

•As a business grows control of activities gets harder•As the firm gets bigger and new parts of the business are set up it is increasingly likely people will be working in different ways and this leads to problems with monitoring

Motivation •As businesses grow it is harder to make everyone feel as though they belong •Less contact between senior managers and employees so employees can feel less involved•Smaller businesses often have a better team environment which is lost when they grow

Diseconomies of Scale

Capacity Utilisation

• This looks at the amount a firm is producing compared with how much it could be producing given existing resources

• To increase capacity utilisation can increase production levels

• Need to ensure there is demand for the excess production

Capacity utilisation

• If produce more need to increase demand by:– Increased promotion– Altering elements of the marketing mix to increase

demand– Producing products for other firms (sub contracting)

Rationalisation

• Where firms are producing under capacity however don’t foresee an increase in demand they will reduce production to cut costs

Capital Vs labour intensity

• Capital intensive businesses are where there is a high level of capital equipment compared to labour input in the production process

• Labour intensive businesses are where there is a high level of labour input compared to capital equipment in the production process

Research and Development

• All activities that look at identifying new products / services and new ways of producing

• Need to be able to turn the ideas into products that can be sold

• Innovation – where new ideas are turned into products

Research and Development - Aims

• To develop new products which have USPs allowing for product differentiation

• Increasing the quality of products to increase customer satisfaction

• To develop more effective ways of producing to decrease costs per unit

• These can all increase the profitability of the business

Research and development process

• The research and development process:– Idea generation– Screening of ideas– Development of ideas– Prototype and testing– Launch

How to protect innovations

• If a business is successful with innovation needs to protect them from competition

• A patent gives the holder sole use of a process / sole manufacture of a product for the next 20 years

• Copyright protects the work of artists / writers and musicians

Research and development and the PLC

• Research and development happens before the introduction phase of the product life cycle

• Research and development is very expensive so can often cause cash flow problems prior to the launch of products

• After launching a product businesses need to do more research and development to modify the product or bring out a new product to increase demand and profit

Research and Development

• If research and development is good then it considers design issues

• In addition it needs to look at :– Customer needs– Use of product / service– Competitors products– Ease of manufacture– Costs / quality / profit targets

Research and Development and Risk

• All research and development contains an element of risk

• Therefore businesses need to ensure that research and development minimizes risk to get required results

• Cant guarantee the success of innovations however firms can try and encourage and support research and development

Why use CPA?

Critical Path Analysis is a planning and management tool with the following advantages:

• Allows a business to plan ahead- efficiency

• Is time related giving an accurate plan

• Enables resources to be planned ahead

• Allows for good management

• Helps with cash flow management

• Reduces waste

Critical Path Analysis

• May be used as part of the decision making process to allow a business to plan and monitor operations

• Time related – identifies the maximum time for an operation to be completed

• Identify potential problems in implementing operation• Identifies where and when resources (including human ones) are

needed

Critical Path Analysis• Advantages

– Maximise efficiency in the use of time

– Improve efficiency and generate cost saving in the use of resources

– Beneficial to monitoring cash flow

• Disadvantages– Usefulness may be limited

in complex and large scale operations

– Necessity of having clear and reliable information

– Skilled management and team philosophy is essential

CPA – the Process

• Identify and prioritise the activities and how long each task will take to do

• Identify which activities MUST be done before others• EST – identify earliest start time• LFT – identify latest finish time• Identify the FLOAT – tasks which can be completed outside

the critical path• Identify the critical path – points connecting ESTs and LFTs

(where these are the same)

Critical Path Analysis

Nodes: Show the start and finish of a task

1 2

Node numbers showing order of activities in the left hand semi-circle

of each node.

5

Earliest Start Time (EST)

5

Latest Finish Time (LFT)

A

3

B

5

Arrows indicate the order of the tasks, the

letter above shows the order, the

time period below the

arrow

The Critical Path

Summary • Economies of scale are were costs per unit decrease as a firm grows in size• Internal economies are specific to one firm as it grows in size e.g. technical,

purchasing, marketing• External economies involve a number of firms • Diseconomies of scale occur when the firm experiences a rise in unit costs as the

firm grows e.g. communication • Capacity utilisation measures how much of the production capacity is used by the

organisation • Capital intensity is where production is most reliant on capital• Labour intensity is where production is most reliant on labour • Research and development is where businesses come up with new ideas for

products and processes• Critical Path Analysis is a planning and management tool