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Unformatted text preview: markets. — Reputation effects and umbrella branding. • R&D • Purchasing Economies. — Cheaper in bulk. • Incentive and Bureaucracy Effects. • Spreading Speed Resources Too Thin. e.g. The excellent chef. ECL 2-20 R.E. Marks ECL 2-21 R.E. Marks 2.5.5 The Learning Curve 2.5.6 The Learning Curve v. Economies of Scale The importance of experience, or learning by doing. ECL 2-22 The former: reductions in unit cost with accumulating experience and production. The latter: reductions in unit cost with a larger scale per period. Economies of scale: the cost advantages flowing from producing a larger flow of output in a given period. The learning curve (or experience curve): the cost advantages flowing from accumulating experience and know-how. A progress ratio is the ratio of average costs after and before cumulative production increases: AC 2 AC 1 , where AC 2 is the Average Cost at cumulative output Q 2 and AC 1 is the Average Cost at cumulative output Q 1 , where Q 2 = 2Q 1 . The median progress ratio is about 0.80, which means that for the typical firm doubling cumulative output reduces unit costs by about 20%. Such learning and cost reductions may slow and eventually be exhausted. Learning by doing applies to quality as well as to costs. Learning economies can be substantial even when economies of scale are minimal: Economies of scale can be substantial even when learning economies are minimal: e.g. simple capital-intensive activities, such as can manufacturing. If a large firm has lower unit costs because of economies of scale, then any cutbacks in production will raise unit costs. If lower costs are the result of learning, then cutbacks do not necessarily result in high unit costs. R.E. Marks ECL 2-23 2.6 The Importance of Scale and Scope Economies: Firm Size, Profitability, and Market Structure Economies of scale and scope provide large firms with an inherent cost advantage. This encourages small firms to try to grow, but limits the numbers of firms that can successfully compete. 2.6.1 Scale, Scope, and Firm Size Scale and scope economies give large firms an AC advantage over small firms. In industries where buyers are price sensitive, large firms can pass along some of their AC advantage to consumers, which drives small (and therefore higher-AC) firms out of business or into niches. If small firms are to match the low AC of large firms, they must grow, through: • retained earnings, • increased equity, • higher debt • product portfolio management (Cash Cows v. Rising Stars etc.) • new product development • geographical diversification • mergers R.E. Marks ECL 2-24 Corporate mergers may be “synergistic”: synergies are economies of scale waiting to be exploited — should a merger be permitted between two large firms which may create some market (or monopoly) power if the merger allows the new firm to achieve substantial efficiencies through economies of scale? R.E. Marks ECL 2-25 R.E. Marks ECL 2-26 2.6.2 M...
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