AQA Business Studies Unit 3 – Strategies for Success
Scale and Resource Mix
Introduction
A business needs to ensure that its costs are kept as low as possible in order to compete
effectively. But what size should a business be to operate efficiently?
This topic looks at the issue of business scale and the related topic of how a business should
mix labour resources with capital resources.
A key concept in this topic is that of “unit costs”.
Most businesses can measure their output (scale) in terms of volume or numbers produced.
For example, output might be:
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10,000 customers per month
150,000 widgets per year
250 meals per day
If a business knows what its total costs are for a period, then it can work out an important
measure – average cost per unit:
Economies of scale
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Why can you now buy a high-performance laptop for just a few hundred pounds when
a similar computer might have cost you over £2,000 just a few years ago?
Why is the average price of digital cameras falling all the time whilst the functions and
performance level are always on the rise?
How can IKEA profitably sell flat-pack furniture at what seem impossibly low prices?
The answer is – economies of scale. Scale economies have brought down the unit costs of
production and have fed through to lower prices for consumers.
Most firms find that, as their production output increases, they can achieve lower costs per
unit. This can be illustrated as follows:
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AQA Business Studies Unit 3 – Strategies for Success
In the diagram above, you can see that unit costs fall from AC1 to AC2 when output increases
from Q1 to Q2. That illustrates the effect of economies of scale – so what are they?
Economies of scale are the cost advantages that a business can exploit by expanding their
scale of production. The effect of economies of scale is to reduce the average (unit) costs of
production.
There are many different types of economy of scale and depending on the particular
characteristics of an industry, some are more important than others.
Internal economies of scale
Internal economies of scale arise from the growth of the business itself. Examples include:
Technical economies of scale:
Large-scale businesses can afford to invest in expensive and specialist capital machinery. For
example, a supermarket chain such as Tesco or Sainsbury’s can invest in technology that
improves stock control. It might not, however, be viable or cost-efficient for a small corner
shop to buy this technology.
Specialisation of the workforce
Larger businesses split complex production processes into separate tasks to boost
productivity. By specialising in certain tasks or processes, the workforce is able to produce
more output in the same time.
Marketing economies of scale
A large firm can spread its advertising and marketing budget over a large output and it can
purchase its inputs in bulk at negotiated discounted prices if it has sufficient negotiation
power in the market. A good example would be the ability of the electricity generators to
negotiate lower prices when negotiating coal and gas supply contracts. The major food
retailers also have buying power when purchasing supplies from farmers and other suppliers.
Managerial economies of scale
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AQA Business Studies Unit 3 – Strategies for Success
This is a form of division of labour. Large-scale manufacturers employ specialists to supervise
production systems, manage marketing systems and oversee human resources.
Financial economies of scale
Larger firms are usually rated by the financial markets to be more ‘credit worthy’ and have
access to credit facilities, with favourable rates of borrowing. In contrast, smaller firms often
face higher rates of interest on overdrafts and loans. Businesses quoted on the stock market
can normally raise fresh money (i.e. extra financial capital) more cheaply through the issue of
shares. They are also likely to pay a lower rate of interest on new company bonds issued
through the capital markets.
Network economies of scale
Network economies are best explained by saying that the extra cost of adding one more user
to the network is close to zero, but the resulting benefits may be huge because each new user
to the network can then interact, trade with all of the existing members or parts of the
network. The expansion of e-commerce is a great example of network economies of scale – it
doesn’t cost Amazon.co.uk much (if anything) to add another 10,000 customers to its
systems, but the revenue and profit effect can be significant.
External economies of scale
External economies of scale occur within an industry. Examples of external economies of
scale include:
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Development of research and development facilities in local universities that several
businesses in an area can benefit from
Spending by a local authority on improving the transport network for a local town or
city
Relocation of component suppliers and other support businesses close to the main
centre of manufacturing are also an external cost saving
Diseconomies of scale
A business may eventually experience a rise in unit costs caused by diseconomies of scale.
Diseconomies of scale a firm may experience relate to:
High capacity utilisation – if the business is operating at too high utilisation, then production
assets are more likely to break down. Machinery may require more maintenance or
replacement; people (in a service industry) may become de-motivated, resulting in lower
quality and productivity
Control – monitoring the productivity and the quality of output from thousands of employees
in big businesses is imperfect and costly – this links to the concept of the principal-agent
problem – how best can managers assess the performance of their workforce when each of
the stakeholders may have a different objective or motivation?
Communication and co-operation - workers in larger firms may feel a sense of alienation and
subsequent loss of morale. If they do not consider themselves to be an integral part of the
business, their productivity may fall leading to higher wastage and higher costs
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AQA Business Studies Unit 3 – Strategies for Success
Capital and labour intensity
The production operations of any business combine two factor inputs:
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Labour – i.e. management, employees (full-time, part-time, temporary etc)
Capital – i.e. plant & machinery, IT systems, buildings, vehicles, offices
The relatively importance of labour and capital to a specific business can be described broadly
in terms of their “intensity” (or to put it another way, significance).
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Labour-intensive production relies mainly on labour
Capital-intensive production relies mainly on capital
Sounds simple! Some examples will help reinforce the point:
Labour intensive
Capital intensive
Food processing (e.g. ready meals)
Oil extraction & refining
Hotels & restaurants
Car manufacturing
Fruit farming / picking
Web hosting
Hairdressing & other personal services
Intensive arable farming
Coal mining
Transport (airports, railways etc)
The main features of each category can also be summarised as follows:
Labour intensive
Capital intensive
Labour costs higher than capital costs
Capital costs higher than labour costs
Costs are mainly variable in nature = lower
breakeven output
Costs are mainly fixed in nature = higher
breakeven output
Firms benefit from access to sources of lowcost labour
Firms benefit from access to low-cost, longterm financing
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