Economies of Scale Economies of Scope in long run

Economies of Scale Economies of Scope in long run Paridhi GuptaIntroductionEconomies all about(predicate) cost rigiveness. The border Scale is all about the benefits gained by the production of large volume of a product. The term scope is linked to the benefits gained by producing a wide com departmentalisation of products by efficiently utilizing to same operations.What argon Economies of Scale?The term economies of weighing machine refers to a situation where the cost of producing one whole of a good or service decreases as the volume of production appends.Economies of scale arise when the cost per unit falls as output increases. Economies of scale ar the important benefit of increasing the scale of production.Examples-Table 1Assume each unit of capital = Rs.5, Land = Rs.8 and Labour = Rs.2Calculate TC and therefore AC for the ii contrasting scales (sizes) of production facilityAC = TC / QTABLE 2Doubling the scale of production (a rise of 100%) has led to an increase i n output of 200% therefore cost of productionPER UNIT has fallenDont model confused in the midst of Total Cost and clean CostOverall costs will rise but unit costs can fallClassification of Economies of ScaleMarshall made a differentiating concepts of internal and external economies of scale. That is that when costs of input factors of production go down, it is a positive externality for all the loyals in the market place, outside the control of any(prenominal) of the firms.Internal Economies of ScaleInternal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself. This means that the internal economies are exclusively available to the expanding firm.Internal economies of scale may be classified under the following categories.Bulk- buy economiesAs businesses grow they need to order big quantities of production inputs. For example, they will more raw materials. As the order value increases, a business obtains more bargaining powe r with suppliers. It may be able to obtain discounts and lower prices for the raw materials.Technical economiesBusinesses with large-scale production can use more advance machinery (or use existing machinery more efficiently). This may include using mass production techniques, which are a more efficient form of production. A larger firm can also afford to invest more in research and development.Financial economiesMany small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often quite high. This is because small businesses are perceived as existence adventureier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates.Marketing economiesEconomies in trade arise from the large scale purchase of raw materials and other material inputs and large scale selling of the firms own product. Every part of merchandising has a cost particularly promotional methods such as advertising and running a sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales not bad(p) the average marketing cost per unit.Managerial economiesAs a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing, human imagination management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles.External economies of scaleExternal economies of scale occur when a firm benefits from lower unit costs as a result of the whole industry growing in size. External economies accrue to the expanding firms from advantages arising outside the firm e.g. in the input markets.The main types areTransport and communication As an industr y establishes itself and grows in a particular region, it is likely that the government will provide better transport and communication links to break accessibility to the region. This will lower transport costs for firms in the area as journey times are reduced and also attract more potential customers. For example, an area of Scotland known as Silicon Glen has attracted many high-tech firms and as a result improved air and roadway links have been built in the region.Training and education takes more focused on the industryUniversities and colleges will offer more courses suitable for a career in the industry which has become dominant in a region or nationally. For example, there are many more IT courses at being offered at colleges as the whole IT industry in the UK has developed recently. This means firms can benefit from having a larger pool of appropriately skilled workers to kindle from.Other industries grow to support this industryA ne cardinalrk of suppliers or support i ndustries may grow in size and/or locate secretive to the main industry. This means a firm has a greater chance of finding a high quality yet affordable supplier conterminous to their site.The long run average cost curve (LRAC)The long run average cost curve (LRAC) is known as the envelope curve and is unremarkably drawn on the assumption of their being an infinite number of plant sizes hence its smooth appearance in the next diagram below.The points of tangency between LRAC and SRAC curves do not occur at the minimum points of the SRAC curves except at the point where the minimum efficient scale (MES) is achieved.If LRAC is falling when output is increasing then the firm is experiencing economies of scale. For example a doubling of factor inputs superpower lead to a more than doubling of output.Economies of scopeEconomies of scope is a term that refers to the reduction of per-unit costs through the production of a wider variety of goods or services.Many firms produce more tha n one product. Sometimes, a firms products are fast linkes to one another. An automobile company, for instance, produces automobiles and trucks, a chicken farm produces poultry and eggs. At other times, firms produce physically unrelated products. In both caes, however, a firm is likely to enjoy production or cost advantages when it produces two or more products.These advantages could result from the joint use of inputs or production facilities, joint marketing programs, or possibly the cost savings of a common administration.Example of Economies of ScopeMcDonalds can produce both hamburgers and French fries at a lower average cost than what it would cost two separate firms to produce the same goods. This is because McDonalds hamburgers and French fries share the use of food storage, preparation facilities, and so forth during production.Difference between economies of scale and economies of scopeMergers and AcquisitionsMergers are basically combining of two business entities under common ownership. Two companies legally become one. All assets and liabilities being merged out of existence become assets and liabilities of surviving company.Under encyclopedisms one firm buys the assets or shares of another. Acquired company becomes subsidiary of purchasing company. unalike Types of MergersA horizontal merger This kind of merger exists between two companies who compete in the same industry segment.A vertical merger steep merger is a kind in which two or more companies in the same industry but in different fields liquify together in business.Co-generic mergers Co-generic merger is a kind in which two or more companies in association are almost way or the other related to the production processes, business markets, or basic required technologies.Conglomerate Mergers Conglomerate merger is a kind of venture in which two or more companies belonging to different industrial sectors combine their operations diametric Types of acquisitionsFriendly acquisition B oth the companies approve of the acquisition under matey terms.Reverse acquisition A private company takes over a public company.Back flip acquisition- A very rare case of acquisition in which, the purchasing company becomes a subsidiary of the purchased company.Hostile acquisition Here, as the name suggests, the entire process is done by force.Motives for Mergers AcquisitionsEconomies of large scale business large scale business organization enjoys both internal and external economies.Elimination of competition It eliminates severe, intense and wasteful expenditure by different competing organizations.Desire to enjoy monopoly power MA leads to monopolistic control in the market.Adoption of modern engineering science corporate organization requires large resourcesLack of technical and managerial talent Industrialization, scarcity of entrepreneurial, managerial and technical talentCreation of Synergies The financial benefit that two companies may derive from a merger or a cquisition is called synergism. The synergetic effect may also refer to the cost reduction a merger brings about by eliminating or streamlining redundant processes.Different types of Synergies enjoyed through MAManagement SynergyManagement synergy refers that the companies use its extensive and efficient management resources through impudently permutations and combinations after MA to improve the existing management and finally increase the tax revenue.Operating SynergyOperating synergy refers to the improvement of production and operation efficiency of enterprises which caused by economies of scale and parsimony of scope after MA.Financial SynergyFinancial synergy refers to the financial benefits generated by MA transaction. It is a net cash flow on benefits which are caused by tax laws, accounting standards and other purveys of the securities and exchange.Production SynergyTwo companies that merge may be able to produce more revenue than either one could produce independentl y by combining the most efficient processes each brings to the merger.Risks Analysis of the Realization of Synergistic EffectThe risk of exposures of the realization of synergistic effect refers to the un sealedty of the increment of corporation value and the performance of strategic MA. Such risks always exist throughout the whole process of synergistic effect realization. From the view of the root causes of the risks, such risks can be divided into internal risks and external risksInternal RisksInternal risks mainly refer to the synergistic effect of risks which is caused by MA transactions and consolidation. Synergistic effect of internal risks mainly includesfinancial riskintegration riskanti-MA riskprincipal-agent riskasymmetric information risk1) Financial risk.MA often requires large arrives of capital, how to raise funds in short term is very important. Companies can use cash, stock or debt financial support for the MA. Either way, there are great risks. If companies use cash to complete the MA, there will have the following short-comings first of all, a one-time large amount of cash outflow for MA will cause intense pressure on the production and management of the enterprise. Second, the trade size will be restrict by the ability to obtain cash and lead to the failure of a large-scale MA. Moreover, the merged side may not like cash payment, because they cannot get the new companys equity, this situation will also lead to MA risks.2) Integration risk.According to a survey on the failure of MA, about 80% of MA failures are caused by enterprise integration failures. The MA integration risk is manifested mainly in the following three aspects first, production and technology cannot achieve the expected synergy after MA. For example, the MA side usually wants to implement diversification through MA so as to enter new areas, when the growth of the new areas are faced with obstacles, it often makes MA activities in trouble. Second, the integration of per sonnel, institution and culture after MA. If the enterprise cannot make effective integration according to the designed MA plan, this will lead to the conflict of personnel, institution and cultural be-tween new and old enterprises and resulting in internal friction. Third, the impact of MA on business descents, such as the impact on customers and suppliers. MA efficacy cause deterioration in external business relationship and lose some customers and suppliers, thus lead to the increase of enterprises operating costs and reduction its profitability.3) Anti-MA riskUnder normal circumstances, the merged enterprises office of MA is uncooperative. Because the merged enterprises are usually inferior enterprises, they will find ways to stop MA. Such practices will greatly increase the MA risks. In addition, under the modern corporate governance structure, a successful MA moldiness first be accepted by enterprise management, then adopt by the board of directors in the enterprise, at la st obtain the consent of the large, small and medium-sized investors.4) Principal-agent riskFor pursuing business expansion, the senior executives with information superiority might ignore the interests of shareholders to meet the needs of their individual fame and fortune. The out of control risk of principal-agent relationship in MA decision is very dangerous. In a company, the relationship between its manager and corporate owners is principal-agent relationship. The company management might pursuit company expansion for their own interests to show their performance. They have information superiority and might agree on the unreasonable terms of the target company without considering its own financial and operating conditions. This conduct will increase the realization cost of synergy and reduced synergy benefits.5) Asymmetric information riskIn the market mechanism of incomplete competition, the problem of information asymmetry is quite general. During the course of surd companys acquisition of target company, the target companys executives might conceal the facts such as enterprises hidden losses of contingent liability and the true value of patents to achieve their private intentions. They might also collude with the agency or the insider of the strong enterprise to make delusive information so that the policy makers of the merging side might make wrong decisions.External RisksAs synergistic effect is based on certain of development strategy and the formulation of such a development strategy is based on external environment, therefore, the changes in external environment not simply affects the enterprises development strategy, but also cause the deviation from the expected synergies. The external risks of synergistic effect mainly includepolicy risklegal riskindustrial risk.1) Policy risk.Policy risk refers to the synergy risk which caused by the adjustment of national economic policies. The government develops special policies to hold dear the vested interests of government and special groups or uses administrative means to arbitrarily change its policy to destroy the normal order of market competition, such behavior would increase the risk of synergy.2) Legal risk.Legal risk mainly lies in the following three aspects. The first is the provisions of anti-monopoly law. Most of western countries developed a serial publication of anti-monopoly laws to safeguard fair competition. The second is the specific provisions of MA in the law. For instance, according to the correlated laws, if the acquirer holds 5% of a listed companys shares, it must notice and suspend trading, for each 2% subsequent increment, it is necessary to repeat the process, if holding 30% of the shares, it must launch a comprehensive tender offer. This provision leads to great increase of the acquisition costs and MA risk. Thirdly, during the course of MA, as laws and regulations are incomplete, the conduct of company cannot be guided correctly, thus result in the increase of MA risk.3) Industrial risk.Industry risk refers to the uncertainty of the industry prospects caused by the changes of countrys economic situation and industrial policy, which might modulate the enterprise development strategy. In the process of MA decision-making, many enterprises sink into woeful situation because they are not familiar with the new industry they compliments to enter or without a accurate grasp of the industry prospects. The big diving of e-commerce enterprises in the last two years are good examples. proofBibliographyhttp//tutor2u.net/economics/content/essentials/economies_scale_scope.htmhttp//www.tutor2u.net/business/gcse/downloads/production_economies_of_scale.pdfwww.scirp.org/journal/PaperDownload.aspx?paperID=4385Pindyck, Rubinfield, Mehta, MicroEconomics, 7th Edition, Pearson